Shall Smart Beta ETF Issuers Disclose Their “Secret Formula”?

This week I attended the “Exchange Traded Forum 2016” in Toronot. The event was fabulous. Industry elite from Canada, US and Europe shared their thoughts and visions about ETFs. Hudreds of advisors and ETF practioners participated the two day event. It is absolutely a grand feast for ETF lovers like me.

One small topic drew my special attention. It’s about if the smart beta ETF issuers should disclose their indexes, detailed methodologies, or we can also call it “secret formula”. During a panel discussion about smart beta in the first day’s meeting, the panelist from a smart beta issuer introduced their smart beta funds. He repeated several adjectives related to their funds: rule-based, multi-facotr, quantitative. But he was challenged by other panlists by a series of questions: (1) is this fund actually an actively managed fund wraped in a ETF? (2) Does the fund have a “pilot” or it is “autopiloted”? (3) By what degree the rule based fund manager play an active role in stock picking? (4) Since it is rule based, why no index disclosed? Is there a black box?

These questions are just what I want to ask if I have the chance. When I read that issuer’s ETF prospectus one year ago, question marks arised. The fund claimed it is rule based, but I didn’t see any index or detailed methodolgy of the calculation of the stock weighting allocation.

The panelist answered: (1) We are rule-based, but we also use fund manager’s discretion; (2) we can create an index, but it is not requried by the current regulation. (3) We save the cost of indexing (generally this work is outsourced from index providers) so that we can benefit our clients. (4) We have significant distribution capability (if my understanding is not wrong, he may imply that the lacking of index is not a issue).

Interestingly in the second day’s meeting, another speaker from the US mentioned this discussion. He said he agrees with the panelist’s standpoint and believe no-indexing or self-indexing (i.e. don’t rely on index providers) may be a industry trend due to its cost saving benefit.

My personal perceptions in regards to this discussion are two-sides:

1, On the “pro” side, what the ETF issuer panelist had said are facts. On the fund’s webiste, it clearly notes “Key differentiators of the ETF include professional money management – no index”. Although not every actively managed ETF can provide an index, most of the real rule-based quantitive ETFs can formulate their indexes. For these non-traditional ETFs, it is not mandatory to disclose the detail of methodology. This is also common in the US, especially among some newly launched small smart beta ETF providers.

2, On the “con” side, I want to say transparency is a lable of the ETF industry, and one of the sources of the fund’s competitiveness, although it also means cost. An example is Goldman Sachs’ Active Beta US Large Cap ETF (symbol GSLC). It is rule-based, quantitative and multi-factor. It also provide “target weight buffers”, which means fund manager has some discretionary authority. The fund disclosed detailed calcaulation methodologis of how the weigtings are allocated amongh three factors. It is trasparent,  persuasive and representing the high standard of the industry practice.






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