How Much Should Smart Beta Cost?

One provider thinks it should be free—at least if it doesn’t outperform traditional indexes.

Investors should only pay for factor-based indexes if they prove they are superior to traditional cap-weighted benchmarks—so says EDHEC Risk Institute (ERI).

“Smart beta providers’ claims on the quality and robustness of their strategies should materialize in their live performance.”ERI Scientific Beta, the nonprofit’s smart beta index provider, has introduced a new pricing model for its benchmarks that it claims will “disrupt the traditional model of fixed fees.”

Investors who choose the new “variable fees” option—available from today—will pay “zero fixed fees,” the group said. Fees will kick in once the multi-strategy index outperforms its cap-weighted benchmark.

“Our rationale for this mandate offer is that smart beta providers’ claims on the quality and robustness of their strategies should materialize in their live performance,” said Noël Amenc, CEO of ERI Scientific Beta. “Our initiative is intended to provide consistency between the smart beta provider’s revenues and the quality of its offering. It is also testimony to the confidence we have in the performance of our smart beta indexes.”

It is not the first time a product provider has attempted a performance-fee only approach. In 2011, UK boutique Vinculum Asset Management launched a quantitative fund promising to charge only a quarterly performance fee. However, after a lack of support from retail investors and inconsistent returns, the group shut down in 2014.

Amenc was bullish in his group’s ability to make this fee approach stick. Speaking to journalists in London last week, he pointed to ERI’s well-established business, which has $10 billion of assets linked to its indexes.

“The fixed costs are already paid,” Amenc said, adding that ERI’s nonprofit status meant it was not required to take more in charges than necessary. Replication costs are “probably nothing,” he argued, meaning the implementation of a service should be the only thing for which clients pay.

“We are aligning remuneration with the promise of outperformance, and affirming our confidence in the robustness of our indexes,” Amenc said.

Earlier this year, a report from Morningstar argued that some exchange-traded fund providers were charging up to three times more for “strategic beta” strategies than for traditional index trackers. There was little justification for the higher fees beyond a lack of pricing pressure, Morningstar claimed.

Related: The Hidden Costs of Passive Investing & The True Cost of Smart Beta