New, mul­ti­fac­tor funds help to cre­ate diver­si­fi­ca­tion and also as­sist with as­set al­lo­ca­tion

Financial Mail - Investors Monthly - - Contents -

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

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