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Advisor ETF Intelligence


Low cost, high value: Active ETFs help to bring stability, growth to portfolios

These low-cost investments have been growing rapidly with proponents espousing the merits of passive index investing

By: Joel Schlesinger

Date: September 18, 2017

It’s certainly no secret exchange-traded funds (ETFs) are changing the investment landscape – for better and for worse.

These low-cost investments have been growing rapidly over the last decade with proponents espousing the merits of passive index investing. This has particularly had an impact on advisers now moving to fee-based models to meet new CRM-2 (client relationship model 2) regulations, says Ahmed Farooq, vice-president of ETF business development at Franklin Templeton Investments Canada.

“They’re converting their business from transactional to fee-based,” he says, adding low-cost ETFs offer a lot of advantages in an increasingly cost-conscious marketplace.

Yet many financial advisers are also not entirely comfortable with passive investing — buying an index — for a number of good reasons, including the potential risks high volatility, over-concentration, and over-valuation.

And the industry has responded with a growing of number active and smart beta ETF options. While smart beta involves layering rules-based strategies over a basket of stocks, such as filtering out high-volatility stocks, active management ETFs aim to capture what made mutual funds popular: expertise.

“With actively managed mandates, advisers can talk to clients about how great money managers have navigated risks and taken advantage of opportunities,” says Mr. Farooq, a veteran of the Canadian ETF marketplace who leads Franklin Templeton’s ETF business development.

“This way the clients win because they’re getting a lower cost product and advisers can still maintain a fee structure compensating them for their advice.”

Even more significant is active management ETFs adjust to changing conditions, based on what managers see occurring in the markets, such as a natural disaster affecting oil production, putting a squeeze on supply and pushing up the value of producers.

“With an active manager involved, you have the ability to get access to sectors based on their upside potential instead of their relative weighting in the index.”

Mr. Farooq adds this is a fast-growing segment of the ETF market because of the value it offers investors.

With a long history of managing the top mutual funds in Canada, the U.S. and around the world, Franklin Templeton saw an opportunity to help advisers and their clients when it conceived of its new lineup of ETFs.

“We wanted to be a little different, but we also wanted to price products aggressively to ensure they don’t get lost among all the other ETFs,” he says.

Launched in the spring under the name Franklin Liberty Shares, the investment firm now offers two active management ETFs alongside two smart beta options.

The two active ETFs leverage the expertise of its award-winning, Calgary-based, investment arm Franklin Bissett.

“These managers have expertise in quantitative and fundamental equity and fixed income management,” Mr. Farooq says, adding Franklin Bissett manages about $20-billion for retail, high net worth and institutional investors. “And they’ve done very well, so we transported their management styles into these products.”

In particular, the Liberty Shares’ active management offerings mirror Franklin Bissett’s winning strategies.

More importantly, these ETFs fill niches in the marketplace so advisers can better serve clients.

The Franklin Liberty Risk Managed Canadian Equity ETF provides exposure to the TSX (FLRM), for example, using a low volatility equity strategy with a management fee of just 30 basis points—the lowest among all active ETFs in Canada.

“We built a portfolio that is sector neutral, but we also added some key traits that are very innovative,” Mr. Farooq says.

For one, the ETF does not only hold defensive sector stocks, which may underperform during bull markets. Fund management can add more cyclical, higher returning securities to the mix to participate more in the upside.

Even more innovative is the team’s ability to use put options as a defensive strategy overlay.

“It’s like an insurance policy against sudden drops in the marketplace,” Mr. Farooq says.

Franklin Templeton’s fixed income offering is equally unique.

“When we looked at the Canadian ETF marketplace, we found there were a lot of passive investment grade bond funds, but on the active side, there was only one,” he says.

“So we felt this was a great area for us to come in at a lower cost than our competitor at the same price as the leading passive fixed income ETF.”

Indeed, Franklin Liberty Canadian Investment Grade Corporate ETF (FLCI) fits the bill at 40 basis points for a management fee.

“What we’re doing a little differently is overweighting the BBB+ bond space to get a bit higher yield to maturity while lowering duration a little because rates are rising,” Mr. Farooq says.

“Buying the bond index, in contrast, you’re stuck with the benchmark where bonds are higher quality, but with a lower yield the maturity.”

This ETF serves a few needs for advisers who seek higher yields for clients but are concerned about duration risk.

“With a passive instrument, an adviser has to worry about whether to move to short duration bonds and what we found as a result is a growing appetite for active management in fixed income.”

Like the equity offering, FLCI provides a balance between offense and defense, adding risk to get return when necessary and while protecting against the downside.

And perhaps most importantly at a management cost that leads the industry.

“As an adviser, you may not benefit from all of the market upsides with an active ETF, but if the ETF is successful in reducing the full impact of losses when markets fall, it’s likely your clients can happily live with that,” Mr. Farooq says. “Key to all this, however, is these ETFs are innovative and priced aggressively to meet the needs of advisers and their clients.”

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