The 2 biggest factors driving growth in active ETFs

Apr 11, 2014 @ 12:00 am

Runtime: 7:12

The debut of The ETF Exchange features Ugo Egbunike, ETF.com's director of business development, as he breaks down the two biggest factors driving active ETF growth while also covering the meaning and importance of 'smart beta'.

Video Transcript

[MUSIC] Exchange Traded Funds are growing at 20 to 30% a year. What's driving that growth? What are companies coming out with next? Welcome to ETF Exchange. My name is Greg Crawford. We're gonna bring in some industry experts to talk about those issues. Today, we're joined by Ugo Egbunike, Business Development Director at ETF.com. Ugo, thanks for joining us today. Thanks for having me, Greg. So, Ugo, can you tell us a little bit about the growth in active ETFs. What's behind that, what's driving all the interest in active ETFs on the part of, of fund companies? Sure, absolutely. So I think there's two factors there. One, we know that in late December of 2012 the FCC lifted it's moratorium on active ETFs and the use of derivatives in ETFs. So, that probably helped boost the confidence of issuing firms that this was a possibility within the ETF space that sort of releasing the fund strategies to buy side advisors at the end of the day. Secondly, I think it's really a matter of, sort of, the growth of the ETFs, and pushing that sort of frontier of what we see in the ETF space. It's, you know, it's hard to say that you can come out with a new emerging markets ETFs that's, you know, providing you broad market cap and market weighted exposure to the emerging market space. That sort of core strategies have really been done and outdone by the ETF venturers. And we've seen a lot of me too strategies out there. You know, when we talk about active ETFs, we inevitably end up talking smart beta, this thing that people have read all about, advisers are reading about all the time. Is that simply a marketing term that companies have come up with to somehow, you know, sell this idea of an active ETF? I mean what, what is smart beta and what's behind? Smart beta, quite personally, is one of the few terms that probably scares myself and my team over at etf.com. Just because of it's sort of broad use and the fact that there is no real clear definition around it, right? It's really a term that came out of marketing to describe a non-vanilla market cap weighted, market cap selected strategy. But the umbrella of web falls under smart beta is so incredibly broad. You could have a dividend strategy, you could have an equal weighted strategy, you could have a low beta strategy. At the end of the day when we talk about things that are smart beta, what's key to actually look at is the strategy behind these ETFs and more importantly the strategy that their indexes are climbing to provide you exposure to. And these strategies again, are the companies trying to just sell you a, a different flavor of a strategy or is it truly, you know, a strategy that goes a little bit further than say a companion ETF that's not labeled smart beta? You know, it really differs across the board. So, it can be something as simple as an equal weighted strategy that might fall under Smart Beta. But some of these are also by-products of ETF issuers that have actually self-indexed and developed their own strategies in-house, un, or revealed it in the wrapper of their own index and then managed the fund on top of it that tracks that underlying index. So what's key is to first understand, alright, what's my core strategy gonna be? Am I gonna follow a market cap weighted strategy for my core portfolio? And then when you look at the smart beta space. What are the factors that I'm trying to add to this portfolio, the strategies I'm trying to add to this portfolio to compliment that? Is it a momentum based strategy? Is it a value based strategy? Am I looking at a high beta strategy and what sort of outcome did I expect by implementing that strategy into the portfolio? Okay, so you mentioned this idea of self-indexing. And when I think of, of a company sort of creating its own index for its own ETS, I'm thinking there's got to be some conflict there. It sounds like you know, maybe not conflict, but it sounds like another sort of marketing thing that companies can use then to show, oh, our performance is great, look at our index. Are there, are specific issues, if, if an advisor's looking at an ETF the smart beta ETF that's benchmarked against the self-index from a company, what are the issues that the advisor really needs to understand in that case? I think the first key thing to really understand is who the index provider is first and foremost. And secondly, what the index methodology is to the extent that you can actually go through the documents and understand if it's transparent or not in its index methodology. Another key factor to really understand as an adviser is that ETF's don't necessarily have to fully replicate their underlying index. Currently with the Vanguard funds, for instance, that sort of part of their fund philosophy in terms of replicating the underlying index, but that's not true for all the ETF shares out there. So though a, an index might say that you know, we sample this universe or we go about focusing on these group of securities, understand that the fund might do something a little different. So it's key to understand the index methodology first and foremost, but understand how the fund is gonna provide exposure to that index methodology. And what sort of sampling strategies it's gonna put in place to provide that exposure. What are the steps that an advisor needs to take to understand, so that they fully understand the strategies? You talk about knowing what the methodology of an index is, which is very important. But you know, beyond that, you got this list of how many ETFs. And again, they're coming out all the time. Oh, this is a smart beta this and this is smart beta that. What, can you walk us through, Ugo, some of the steps that an advisor could take to really, sort of you know, open the hood, and see, okay, this is where the oil goes, here's where the air filter goes, you know, to help them really know how to understand these, these new products? I think the, so I think the first and foremost strategy that an adviser has to go through really starts with themselves, right. What is your objective with this portfolio? Is it income preservation? Is it capitol appreciation? At the end of the day, really that's where you're going to start. From there you determine, alright, what strategies am I willing to implement to this portfolio? Am I comfortable with the momentum strategy? Am I comfortable with the value based strategy? Am I comfortable with an equal waiting strategy? Do I want to tilt towards small caps? All of those individual factors are gonna help you determine what smart, smart beta plays are gonna be appropriate for you at the end of the day. And then you can sort of try to sift through the umbrella smart-beta strategies that are available to you to say, alright, I know these are all the smart beta strategies that incorporate whether it's value or low beta or high beta. And then from there determine is this something that's gonna actually compliment my portfolio or not. Is this an index methodology that I believe in, do I agree with how often they're bouncing the CTF or this index at the end of the day? And I guess the key, the ultimate key is to, to not get swayed by fancy terms like smart beta, they go oh this is the great, greatest thing; so I can jump right in right? Cuz there's a lot of marketing hype out there. I mean you mentioned smart beta sort of came out of the marketing department, not the, you know, the, the investment management department. [LAUGH] No. As a, as a wrapper, so so that is a key too, to not kinda get swayed by fancy names and fancy strategies, that sound really cutting edge, right? Exactly I mean, there's always some new way of, around but the key is to really sort of sift through the marketing and be sure that you understand first and foremost index methodology and secondly how the fund implements that index methodology. [MUSIC]

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