Ask the expert: Strategic beta ETFs

--  |   07/03/2019 Text size  Decrease  Increase   |  
<p><strong>Glenn Freeman</strong>: In this edition of "Ask the Expert" I'm speaking to Thomas Reif from State Street.</p> <p>Thomas, thank you for your time today.</p> <p><strong>Thomas Reif</strong>: Good morning, Glenn. Thank you.</p> <p>Freeman: Now, we are discussing smart beta or strategic beta as it's called or even active beta. I suppose obvious stating point is to explain what strategic beta is and why is it important, why do investors need to know about this?</p> <p><strong>Reif</strong>: Strategic beta portfolios are designed to target particular factors in the market that drive excess returns. So, they are an active way to harness &ndash; so, they are a portfolio that can harness active expected returns at a low cost.</p> <p><strong>Freeman</strong>: I know the generic or exchange-traded funds sector is valued at around $40 billion and the strategic beta is a subset of that, but it's still growing at quite a substantial rate.</p> <p><strong>Reif</strong>: It's growing at a very fast rate. So, we've got a lot of popularity, particularly among the retirees that can seek some high-yielding ETFs such as WDIV or SYI being global high-yielding ETFs. And there's a lot of interest now in sort of our low-vol &ndash; our Quality Mix Fund which targets sort of low volatility cum high quality and value.</p> <p><strong>Freeman</strong>: Yeah. So, around one-third of the ETF products that are out there in the Australian market are strategic beta. How big a subset of your product mix within State Street?</p> <p><strong>Reif</strong>: Look, by account, it's probably about the same, maybe sort of 20%, 30%. We have some ETFs that target high yield as well as ETFs that target a bunch of strategic factors to give a particular return profile, as well as the core of our index products, just the ASX 200 and the 50 and the (LPT) strategies, of course.</p> <p><strong>Freeman</strong>: And when you are talking about factors, what do you mean in this context?</p> <p><strong>Reif</strong>: Factors are a handful of variables that have been shown to drive returns in the long term. And they can be whittled down to value, size, low volatility, high quality and even high yield. These are characteristics of the stocks that have been shown to drive excess return in the long term.</p> <p><strong>Freeman</strong>: Is it predominantly within the Australian market that you look out for these products? Or you have these smart beta also looking at some of the global stocks?</p> <p><strong>Reif</strong>: We run these particular strategies from all of our portfolio management offices in the world, but in particular the investment universe of the strategies also are global. So, it's a highly diversified strategy that targets these factors across global markets. And indeed, in the research that supports these strategies, they have been tested across multiple markets over long timeframes to show that these excess returns exist in the long-term.</p> <p><strong>Freeman</strong>: And how large are they? In terms of the number of stocks that underpin these products, how many companies typically are within them?</p> <p><strong>Reif</strong>: The Quality Mix strategy in Australia has in the order of 500 securities that it's invested in any point in time and its fund size is between sort of $5 million to $50 million mark.</p> <p><strong>Freeman</strong>: How does that vary across the different tranches that you are talking about in the quality, the low volatility, for instance?</p> <p><strong>Reif</strong>: The Quality Mix Fund is combined by taking equal-weighted thirds of each of the individual smart beta factors of strong value, high-quality and low volatility. The underlying components have a varying number of names. The quality sleeve has about 300 names. The value sleeve has 1,500 names and the low volatility sleeve, I think, has about 500 names. But when you combine those to form the Quality Mix portfolio, some of those trades are too small to implement cost effectively. So, the Quality Mix Fund implements a subset of the target names to be efficient in implementation. And as the strategy grows, it's set to well diversification.</p> <p><strong>Freeman</strong>: And how well have these products performed in, say, a relatively low-return environment? And how well have they been tested in a downturn?</p> <p><strong>Reif</strong>: Look, the testing that underpins these strategies goes back to as long as data can be found for. Say, the value sleeve, so that goes back at least 70 years. Each of the individual sleeves are tested on at least 20 years of data. This strategy has been around for three years, the Quality Mix Fund, in the Australian market and we tend to find that it outperforms more often in down markets relative to &ndash; performs relatively strongly in down markets. It still participates in upside when markets run. But that can be a period when you expect it to lag a little bit &ndash; lag the market a little bit.</p> <p><strong>Freeman</strong>: What are the reasons behind that, that outperformance that you get from these smart beta products during a downturn?</p> <p><strong>Reif</strong>: Glenn, the strategy has been engineered to have that sort of performance profile and the way that we achieve that is by two-thirds of the factor inputs being the low volatility and high quality factors. And both of those components tend to do well in down markets. For instance, when the markets, in a downturn they tend to get more focused on forward-looking earnings and the high-quality companies have more clarity on their forward earnings as well as a lower level of debt. So, when the market goes in downturn, these companies are more comfortable in their cash buffer and tend to outperform. Likewise, low volatility companies are low volatility because they have more certainty with regarding their forward earnings. So, in times of market downturn, when investors are trying to avoid uncertainty, you find low volatility names also outperform. And those two components form the backbone of the Quality Mix strategy, but then it's augmented with the value sleeve which allows some upside participation when markets run.</p>

Video Archive...

Friday fundamentals webinar: Deep dive into ETFs
15/04/2019  Emma Rapaport talks to Morningstar's Alex Prineas about exchange-traded funds and what they can offer for the Australian investor.
Strategic-Beta ETPs on the rise
21/03/2019  Strategic or smart beta exchange traded products continued to expand in 2018 and now make up 10.5 per cent of Australia's ETP market, says Morningstar associate director, manager research Alexander Prineas.
Ask the expert: Strategic beta ETFs
07/03/2019  State Street’s Thomas Reif explains smart beta exchange-traded funds, how style tilts such as value, size and low volatility work, and how such ETFs respond to higher volatility.
Index investors 'get what they don't pay for'
31/01/2019  The late Vanguard founder, Jack Bogle, was a committed believer in index investing and the Cost Matters Hypothesis, says Morningstar's Russ Kinnel.
Changes ahead for ETF investors
15/01/2019  The inclusion of mainland China shares in more indexes including S&P Global, an expanding menu of active ETFs, and the potential for more ESG-focused funds are among trends investors can expect in 2019.
Where ETFs fit in 4 retirement stages
27/11/2018  Exchange-traded funds have pros and cons depending on your investment style and other variables as you approach retirement, along with applications in the accumulation and withdrawal phases, explains State Street's Jonathan Shead.
Australian retirees lack confidence
21/11/2018  Superannuation complexities, investment risk and regulatory uncertainty mean a shortfall in confidence is understandable in our current environment, says State Street’s Jonathan Shead.
The double-edged sword of listed investments
16/11/2018  There are very good reasons for the popularity of listed investment vehicles, but some of these attributes also give rise to potential challenges, explains Morningstar’s Matthew Wilkinson.
The risks of timing factor investing
23/10/2018  Vanguard founder Jack Bogle sees a place for some factor funds but thinks trying to trade between factors is a losing proposition.
Bogle: Index funds should top investor lists
17/10/2018  Vanguard founder Jack Bogle explains the difference between long-term and speculative returns, and where he believes markets are headed over the next decade.
5 megatrends shaping the future of investing
25/09/2018  iShares' Rob Powell talks to Emma Wall about thematic investing and how megatrends are shaping global economies and stock markets.
ETF flows remain strong despite emerging market turmoil
12/09/2018  Currency volatility has rocked emerging market equity returns over the year, but ETF investors are staying the course, says Morningstar Asia director of ETF research Jackie Choy.
Are ETFs overrated?
06/09/2018  Liquidity, transparency, and tax efficiency are hallmarks of ETFs, but Ben Johnson says some of these benefits can be oversold.
Using ETFs to manage portfolio risk
12/06/2018  How active ETFs offer investors a lower-cost alternative to full active management, and are increasingly used for holistic portfolio construction, says BetaShares' Alex Vynokur.
Evolution of ETFs in investor portfolios
08/06/2018  How investors' use of exchange-traded funds is evolving, and why Blackrock hasn't yet pushed into the active side of these vehicles, according to Blackrock iShares' Jonathan Howie.
Are ETFs to blame for market volatility?
07/03/2018  Morningstar associate director of manager research Alex Prineas explains some of the complexities facing ETF investors.
3 macro themes for 2018
31/01/2018  US corporate tax cuts and slow-burning European economic growth feed BlackRock iShares' bullishness on this third market--and equities in general, explains Alex Zaika.
5 steps to decide if ETFs are for you
29/01/2018  Alex Zaika explains what goes into building an exchange-traded fund, and some of the different variables investors need to consider.
Bogle remains unimpressed with strategic beta
30/10/2017  The Vanguard founder says his long-time strategy of sticking to index funds is still the best bet.
Jack Bogle on what's next for active investing
30/10/2017  The Vanguard founder says net withdrawals have been offset by rising stock prices.
Bogle: Vanguard's size a worry
30/10/2017  Diminishing economies of scale and potential regulatory concerns limits how much bigger Vanguard should become, says founder Jack Bogle.
Bogle: Index funds the best hope for corporate governance
25/10/2017  Corporate governance should be based on long-term factors affecting the corporation, and traditional index funds are the only true, long-term investors, says Vanguard founder Jack Bogle.
Bogle: The good and the bad of ETF trading
25/10/2017  Any significant amount of trading will decrease your return relative to the market, says the Vanguard founder.
Bogle: ETF flows muddle valuation, risk picture
25/10/2017  Large swings in ETF flows make it hard to forecast valuations and are likely introducing new risks into the market, says Vanguard founder Jack Bogle.
Bogle's 'reasonable expectations' for market returns
24/10/2017  The Vanguard founder sees 4 per cent returns for stocks and 3 per cent for bonds over the next decade.