New, multifactor funds help to create diversification and also assist with asset allocation
Pure passive is becoming passé, it seems. So while many investors are likely to remain invested in market cap-weighted ETFs, newer funds to the market are increasingly smart beta, which generally weight a fund’s holdings by something other than market capitalisation. In fact, latest entrants to the ETF market have gone a step beyond that and are more likely to be multifactor funds, which blend aspects such as yield, size, value, momentum, quality and low volatility. This results in an entirely different investment outcome, as it severs index weighting from price.
The topic was part of a rather heated discussion at the inaugural ETF Exchange conference at the JSE earlier this month. And while there are those who argued that introducing smart beta detracts from the simplicity of passive index trackers, you can’t argue with the merit of reducing risk, focusing on consistent dividend payers or improving value.
The Satrix 40 ETF was the first ETF in SA back in 2000, tracking, as the name suggests, the FTSE/JSE Top 40 index. The performance of the ETF is skewed to its largest constituents due to their bigger market capitalisations. So a large part of investors’ exposure is to big industrial groups, including SABMiller and Naspers, while Mondi and Investec are almost negligible in the ETF.
Ten years after the first ETF, Nedbank introduced the BettaBeta EWT 40, which weights all components equally — 2,5% for each of the 40 stocks — thereby reducing investors’ exposure to any single stock. The market cap-weighted Satrix 40 is likely to outperform the BettaBeta when the large industrials do well, such as last year. However, those shares have lost some momentum this year, so the BettaBeta should do better. for the average investor who wants to park his or her money where it will earn a decent return. Detractors say that it’s also not enough for your financial adviser to construct an ETF portfolio using these funds; you need a skilled asset allocator to blend the funds together.
So, what’s next? Well, according to Deborah Fuhr, co-founder of independent ETF research and consultancy firm ETFGI.com, there’s a move to active ETFs, with the actively managed bond fund of Janus Fund’s Bill Gross — co-founder of Pimco — converted to an ETF. Whether it gains any traction is debatable, particularly for equity-based ETFs, as they are required to be fully transparent, and there are few fund managers who will want to divulge their holdings on a daily basis.
Some firms have requested permission from the US’s Securities and Exchange Commission to introduce nontransparent active ETFs, and a successful application could drive growth in these funds. Essentially, they would be unit trusts listed on the stock market.
As stated at the outset, there will be those investors who are happy to continue investing in the vanilla, market cap-weighted funds, and so they should; smart beta doesn’t always outperform pure beta, and if active ETFs gain traction, they may not either.
What these additional funds do is to add more instruments to the ETF toolbox to help create diversification and also assist with asset allocation.
It’s hoped the exchange conference, held by CoreShares and co-sponsors iTransact, S&P Dow Jones indices and the JSE, will become a regular event on the ETF calendar, drawing on local and international experience and trends in the industry — and creating a forum where issues like these can be thrashed out.
Some firms have requested permission to introduce nontransparent active ETFs