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.






From Pioneer to Latecomer: TD Re-Enters the ETF Market

TD Global Asset Management registered its ETF lineup in December 2015. It consists of 4 individual funds, 2 of them have CAD hedged version. The funds haven’t been listed on the Toronto Exchange yet. Their preliminary prospectus are available at This is a blockbust for the Canadian ETF market due to TD’s market status in Canada. A series of questions come to my mind: Why does TD do this? What’s special of TD’s products? How will the whole market be shaped in 2016? I tried to find some answers.


Why does TD re-enter the ETF market?

Undoubtedly, TD’s re-entry means the ETF market is something you must have for major participants. It is an overwhelming market trend that no one can be just a spectator.

According to the media news, TD was once the pioneer in the Canadian ETF market. It lauched 4 ETFs in 2001 but exited in 2006 due to low money inflow and trading volume. This is an excellent proof of the importance of timing, just as what was disclosed in a widely spreaded TED speech “The Single Biggest Reason Why Startups Scucceed (June 2015)“. Good business idea is not enough to promise success, timing matters. This time when TD enters again, although we cannot say it is perfect, but I won’t say it is too late.

TD has considerable client assets managed in form of mutual funds. With the approaching of CRM2 implemantation deadline and the increase of consumers’ awareness of MERs, TD have to find substitution for those mutual fund assets. If it have no in-house ETFs, inevitably customers will turn to other ETF providers. So TD has no choice. All the big banks have no choice but to join the battlefield. This is the cold hard truth for the banking industry.

What’s TD’s ETF products strategy?

By reviewing the 4 ETFs, we can see TD is using the strategy of outsourced broad base index and competitive pricing.

1, Currently all the indices are provided by S&P Dow Jones. One of the 4 indices, S&P EPAC EX-Korea LargeMidCap Index was launched just launched on December 7, 2015, looks like a customized index for TD. We can compare it with BMO. BMO has over 60 funds, so it uses many different index providers, such as FTSE, S&P, Solactive and etc.

2, All the 4 ETFs are broad based. We can say that as TD’s first step, it just manufactured some building blocks. If we look at RBC, the strategy is quite different. Its “Quant” series are using rule-based, multi-factor approach. RBC’s Quant series can be regared as smart beta funds though it didn’t use related name. RBC don’t have those basic building blocks. I think RBC’s strategy is more pragmatic as they don’t compete with iShares or Vanguard on those building blocks. From another point of view, I may say TD’s strategy is more aggressive.

3, TD ETFs’ pricing are competitive. We can compare TD’s Canadian Aggregate Bond Index ETF’s management fee with 3 major players in the marekt. TD charges 0.10%, iShares Canadian Universe Bond Index ETF (XBB) is 0.30%, BMO Aggregate Bond Index ETF is 0.20%, Vanguard Canadian Aggregate Bond Index ETF is 0.12%. Although these ETFs track different index and have different holdings, we still can get some color of TD ETFs’ pricing strategy.

How will the Canadian ETF market evolve in 2016?

The prosperity of the ETF market needs a ecosystem which includes many participants, such as index providers, fund issuers, exhanges, distributors, regulators and consumers. It takes a long time to cultivate the market and make all parts integrated smoothly. 15 years has passed since the first ETF was launched on Toronto Stock Exchange, 2016 will be a critial year for the ETF market as the majority of big banks entered the market. Here I have some personal prediction for 2016:

1, Big five banks will have some substantial move in the ETF market. BMO may consider sreamlining its lineup as ETF is a scale-do-matter game. RBC has already accelerated its product rolling out speed. TD will hit the ground running in the first quarter of 2016. Scotia and CIBC should have some news related to ETF in the year.

2, Purpose Investment is a company I will pay close attention to. Som Sief, the charismatic CEO who successfully created Claymore Canada, positioned his new company to “change the industry”. I have very postitive anticipation with this company.

3, Regulation should change to adapt to the development of ETFs. Currently most of the retail finance sales people are licensed as mutual fund representative, they cannot talk about ETF products with clients. It is expectable that the license rules will be modified to reflect the industry evolution.

4, Advisors should upgrade themselves to meet clients needs. ETF proliferation and product innovation are so fast that they challenge advisors’ capability of learning new things. Robo-advisors emerge to compete with human beings. Advisors should provide some “Advisor Alpha” which the concept was firstly presented by Vanguard.

Abstract in Chinese /中文摘要: