How and why BetaShares built its latest bespoke ETF

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BetaShares is looking increasingly like a unique sort of fund manager. Its latest exchange-traded product is a credit fund where the firm built the index on which it is based itself, with the help of a specialist index provider. Its listed funds are becoming increasingly sophisticated. It has also taken on about $500 million in mandates from institutional investors.

The latest fund, CRED, eschews the traditional credit investment indices, the main one being the Bloomberg AusBond Composite Index, because of the age-old problem of the most indebted companies taking the largest share of the capital. The same problem arises in emerging market debt strategies, where the indices against which they are measured tend to be dominated by the countries with the weakest balance sheets.

BetaShares has now built several smart-beta-style products with index partners for both domestic and international investing. It has also partnered with active fund managers for their ETPs, mainly AMP Capital and, more recently, Legg Mason. And big funds, which may not want to use the listed market for whatever reason, can gain direct access to the IP through mandates.

The CRED fund, QPON fund (which only invests in senior floating rate bonds to mitigate risk of rising interest rates) and the recent ‘top 200’ listed Australian share fund A200, were all built with index provider Solactive. Two sustainability funds, one for Australian stocks and the other for international, were built with Nasdaq, the US exchange which has been in the index providing market since 1971.

Alex Vynokur, the founder and chief executive, says that the usual growth scenario for the firm’s three fixed income products has been different to most of the other 46 listed vehicles it has launched since establishment in 2010. With fixed income, institutional investors have been the early adopters while the wholesale and retail investors have followed. In the other asset classes the planner-back wholesale investors and individual investors have tended to be first on board.

This, he believes is for two main reasons: most investors have preferred term deposits and bank cash deposits and funds and fixed income tends to be a complicated asset class to understand, especially when you add in currency. But, with the demographic shift of more people in or approaching retirement, this needs to change, he says.

“We’re pragmatic, Vynokur says. “Our starting point [in fixed income]was with the cash ETF, which has about $1.3 billion invested, then the senior bank floating rate bond ETF (QPON), launched last year and with about $250 million invested. Our hybrids fund, HBRD, also has floating rate exposure. So, we have been building a ladder. CRED now completes this.”

BetaShares always looks at what “off-the-shelf” indices are available first before embarking on its own build or tailoring smart-beta style. “We saw the flaws in the debt-weighted indices and set about to solve the problem.”

The CRED ETF bears little relation to what would be constructed to track a plain-vanilla credit index. Difference include:

  • CRED invests only in investment grade corporate issues
  • It also invests only in those issues which are liquid, as defined by liquidity screens
  • The portfolio is equally weighted, rather than cap weighted, and
  • Duration is focused on the longer end of the curve, with maturities between five and 10 years.

The upshot is a portfolio which is not only different from the index but also that of most active credit managers. Active managers tend to have significant variability around duration in their exposures, Vynokur says. “We want fixed income to be true to label and deliver negative correlations with equities, especially under stress conditions when it is needed.

By focusing on longer duration issues, the CRED portfolio is also skewed towards ‘quality’ because riskier loans are more likely to appear at the shorter end where the corporates are less able to be granted longer-term loans. A bonus is that active managers don’t tend to be as active at the longer end.

Vynokur says the BetaShares index “is much tougher to beat” than the Bloomberg index. “So we’d like it to be used as the main benchmark for active managers,” he says. He admits it competes with active managers and raises the bar for them to compete against.

Performance has been comfortably better than the Bloomberg index back to 2008, using real securities data for the analysis. A 50:50 portfolio of Australian equities and CRED would have returned 7.6 per cent with a volatility of 8.1 per cent versus the blend of that same equity portfolio with Bloomberg AusBond Composite’s returning 6.4 per cent with 8.4 per cent volatility. It has also beaten the best active manager in Morningstar’s regular survey of managers over three, five and 10 years. There were fully 55 active managers in the 10-year comparison (74 in five years and 86 in three years).

“It’s the index that makes more sense for Australian investors,” Vynokur says. While he considers his firm, which is owned by management alongside a core investor in Mirae Asset Management, to be a fund manager, he says: “We are in the business of systems, processes and technology. We’re not in the business of hiring rock-star portfolio managers.”

As of June 30, there was $5.7 billion invested in BetaShares funds.

– G.B.

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