ETFs can be used to create a portfolio that meets an investor’s needs, whether it be creating income, building capital or shielding from market risk or inflation risk. Jason Xavier, Head of EMEA ETF Capital Markets, Franklin Templeton explains all in conversation with Beverly Chandler, managing editor, ETF Express.
This episode of Off the Record is sponsored by international asset manager, Franklin Templeton.
ETFs can be used to create a portfolio that meets an investor’s needs, whether it be creating income, building capital or shielding from market risk or inflation risk. Jason Xavier, Head of EMEA ETF Capital Markets, Franklin Templeton explains all in conversation with Beverly Chandler, managing editor, ETF Express.
This episode of Off the Record is sponsored by international asset manager, Franklin Templeton.
Beverly Chandler
Hello, my name is Beverly Chandler and I'm managing editor of ETF Express and I welcome you to the latest edition of Off the Record, the podcast about all things ETF brought to you by ETF Express, and this edition brought to you in partnership with asset manager Franklin Templeton. All views expressed in this podcast are the speakers’ own and we hope suitably controversial. This podcast brings us the second outing with Jason Xavier, head of EMEA ETF Capital Markets for Franklin Templeton and we're going to discuss the varieties of ETFs available and how they can work to create an investor’s portfolio. Jason in our previous outing, we discussed the fundamentals of ETFs explaining what they are and how they work. Would you like to just recap that for me, in one sentence if possible please?
Jason Xavier
Well, thanks for having me again, Beverly. Well, in one sentence. Well, let's give it a go. So exchange traded funds are effectively exactly the same as mutual funds. They do exactly the same as a mutual fund. They give you exposure to an underlying market. However, they give you enhanced features and those the main features around that enhancement is intraday pricing, intraday liquidity, transparency of your holdings, you get daily transparency of your holdings and effectively real cost efficiencies around the management fees of these vehicles. So they're effectively just a fund vehicle just like a mutual fund, with those benefits.
Beverly Chandler
So it's a put a fund being a pooled investment, I think we probably even need to take it down to explain that.
Jason Xavier
Exactly that. A pooled investment, just like a mutual fund.
Beverly Chandler
But listed on a Stock Exchange.
Jason Xavier
Exactly. Listed on the with the added added feature of being listed on the Stock Exchange and giving you that intraday trading, intraday pricing and in some asset classes that intraday price discovery as well.
Beverly Chandler
Fabulous. Thank you. So we're going to look at a variety of ETFs because they do come nowadays in quite a wide variety of different types of investment strategies. Can you tell me to start with when they were first launched, what what were they like the the traditional sort of passive ETF that people might have heard of even. What's that like?
Jason Xavier
Absolutely. So in the early days the the the first ETFs that came to market were effectively what's known as passive products. What does that mean? They are effectively ETFs that track an index and no active management is really done in those portfolios or done in those ETFs. They track an index, they give you the index return. But at Franklin Templeton, we believe that, you know, beta shouldn't break the bank. So we, you know, we look at passive as buying the market and buying the market in a really cost efficient way. Now what do you do when you buy the market? What are you actually investing? You're investing in an index that is weighted based on the size of those stocks. So if you think of the FTSE 100, the FTSE 100 is the 100 largest stocks in the UK and they are put into an index and they are weighted in that index based on the size, the market capitalization of those stocks. So that is a traditional market cap weighted benchmark and that is really the the traditional sort of passive ETFs that you see. So that could be an ETF on the FTSE 100, an ETF on the S&P500 etcetera, etcetera.
Beverly Chandler
So you can buy one ETF that gives you an exposure to all of those companies, underlying companies.
Jason Xavier
Exactly. And that's the real the real benefit of exchange traded funds. They are the only fund vehicle that allows you to gain access to a broad benchmark and trade that broad benchmark throughout the day, buy it in the morning and sell it in the afternoon if you want to. But give you that that, you know, freedom to transact and freedom to make investment decisions in the same sort of real time fashion that investment professionals do in the in the heart of the city.
Beverly Chandler
And then they have advanced from being the passive vanilla type products, and last year I was hearing a lot about thematic ETFs. Tell me what those are.
Jason Xavier
So thematic ETFs are basically ETFs that look to capture and invest in effectively the mega trends that are occurring in the world. So that could be anything from a technology shift, you know Web3 to you know, the future of food, the future of healthcare, vertical farming. A theme like that, that is a transitional theme where we're seeing a lot of investment, we're seeing a lot of a lot of investors looking to get exposed to those themes. Now you can get exposed to those themes in a passive fashion but you can also get exposed to those themes in an active fashion. In Europe, we see a lot of thematics that are passive vehicles as we've just discussed, they're they're index products. So you can argue that the the active decision has already been made. You've made the active, the conscious decision to get exposure to that thing, so to get to then execute on that exposure you should just look for a a vehicle, an ETF, that gives you a very cost efficient way to gain exposure to that market, and rely on the ETF provider to do the do the work in selecting those underlying stocks that will give you the appropriate exposure to the theme that you're interested in. So that's really where we've seen thematics grow.
Beverly Chandler
So they would allow an investor to target their their particular views, what they feel is going to be a growth area. They can create their own investment portfolio effectively by buying, again one share in perhaps an ETF whose underlying index is based on, the as you said like the metaverse, that was hugely popular at one point last year.
Jason Xavier
Exactly that. Exactly that. So you know for individual investors, for retail wealth, institutional investors that are, you know, keeping an eye on the news and seeing how the world is trending and how these mega trends are trending via whatever theme that they're looking at. ETFs and thematic ETFs give you the ability as you said, rightly said, buy one share and get exposure, so you can buy one and, you know, thousands of shares to get exposed to that theme. And depending on your view, depending on what your preference is on those themes will depend on what theme you end up entering into and investing into.
Beverly Chandler
Brilliant. So that's thematic. This year ETFs are dominated by talk of active management, which of course is the complete antithesis of where ETFs came from, that passive background. How can ETFs be used to add active investment management into a portfolio?
Jason Xavier
Beverly, this is the really exciting, exciting time for ETFs.You'll see in the transition as we move from passives into, you know we we mentioned it before, at Franklin Templeton beta shouldn't, we believe beta shouldn't break the bank, right? We also believe that passive doesn't necessarily mean market cap, right? It doesn't have to be, as I described before, just weighted on the largest stocks; you can have alternative weighting schemes. Equally active insights can be put into a rules based index ETF. But now we're transitioning, we're seeing that move to active and this is the really exciting part. This is what gets us excited at Franklin Templeton because specifically within fixed income, we have now seen how fixed income ETFs have taken a over the counter market structure. And for the first time put an over the counter market structure on an exchange and allowed price discovery within bonds. So you have a lot of passive bond ETFs in the marketplace. The real step change now is to see that we're now seeing a lot of active fixed income ETFs and the active fixed income ETFs, that that layer of price discovery that you bring as a result of the ETF wrapper, is hugely powerful for for active fixed income ETFs. So we're seeing more and more active management, active fixed income ETFs come to the market and for me this is a real step change. This is taking again that price discovery and really giving it to end investors. And I've I've commented on this before this you now have individual investors getting the same price discovery, the same ability to transact in a portfolio of bonds with the same price discovery and the same pricing as, you know, institutional investors do in in the centre of the city. So, you know, your mom and pop at home, my parents, they can they can execute on a fixed income portfolio just like our fixed income portfolio managers do at Franklin Templeton. So that democratisation is is a really powerful thing.
Beverly Chandler
And explain to me what you mean by price discovery in that context. Why do you get better price discovery on bonds if you’re in an ETF?
Jason Xavier
So again, it comes back down to the the fundamental market structure. So if you think about the stock market, the stock market, you, we all know that Vodafone has a price and we can all see what Vodafone's price is on the exchange. Now if Vodafone's in the FTSE 100 (and there's obviously lots of telecommunication companies out there) but if you can see the pricing of a particular stock you can then also see the pricing of the ETF as a composite of all of those individual stock prices. But if you look at the bond market structure, there's no centralised exchange for you to get the price of one particular bond. But, you know, the to get a price of one particular bond you have to phone bond dealers and get a comparative price and get your best price. So the market structure, when I talk about the market structure, it's that fundamental difference between the stock market market structure and the bond market market structure, one being centrally cleared on an exchange and one being a bilateral market structure. Now the exchange traded fund, and this is why it's so exciting, the exchange traded fund has taken that market structure, and as a result of the exchange traded fund pricing, you now get that price discovery of the underlying bonds. So let's keep it simple. Let's say that I have two bonds in my ETF and I don't know the prices of the individual bonds but I know the price of the ETF is 100 and I know that each bond has a weight of 50%. Well, I'll know that the price of the underlying bonds are 50 and 50, so that price discovery, we didn't have that before. And it's the exchange traded funds that really that has really given us this and we've seen that accelerated in the passive fixed income ETF space and now we're seeing how a lot of investors, asset managers, they're seeing the benefits of this vehicle within the active fixed income space as well.
Beverly Chandler
That's a fascinating new development. Are there any other types of active management that you're seeing coming through now in ETFs such as a new phenomenon?
Jason Xavier
Well we’re seeing, we're seeing active across the board as well. We are seeing multi asset solutions. We're seeing, you know, the US lead in this in this space. So we've seen a lot of equity multi asset solutions being launched in the US on in the ETF vehicle. For us in Europe, it's really about the active fixed income that we're seeing grow. And again, for me, that structural change, that fundamental price discovery is for me the most exciting and the most appealing part of an active fixed income product.
Beverly Chandler
Another phrase that you hear in the context of ETFs is smart beta. Explain that. It sounds really complicated and a bit scary, so let's break it down. What is it?
Jason Xavier
So, so we, we we spoke earlier about market cap weighted indices like the FTSE 100. Now imagine an alternative. So again, at Franklin Templeton we believe that passive doesn't necessarily have to mean market. It doesn't have to be the market. It doesn't have to be market cap. We believe that you can have alternative ways to weight your portfolio. So let's keep it simple. Let's talk about the FTSE 100 again and instead of now weighting your stocks in the FTSE 100 based on the size of the stock, now let's say we'll base the the weighting based on the dividends that they may pay and the the companies that pay a higher dividend will get a higher weight. Well, that's an example of an alternative weighted scheme, an alternative weighted product. But now imagine if you had not just dividends but you had a price to book ratio as well, and you said I'm gonna take dividends and I'm gonna also take the price to book, and I'm going to give those two weightings of 50-50 and I'm going to rank the stocks based on just those two. Well, those two effectively are two factors. So now the more factors that you add to the weighting scheme, you effectively get what we call a multi factor smart beta approach. So you can think of smart beta and multi factor in in in a kind of similar way. So it's effectively saying that we're going to use an alternative weighting scheme to weight the portfolio, to weight the ETF, but we're going to do it in more than just one, one dimension. We're going to use a couple of different factors to then contribute to a composite weight to support failure.
Beverly Chandler
And the factors, are these the traditional investment factors that one’s heard of, so growth?
Jason Xavier
Exactly.
Beverly Chandler
Yeah. So I can't remember them all, but.
Jason Xavier
Yeah, so so it's the usual, you know, the growth, the quality factors, the growth factors that you see in the stock, the quality factors that you see in the stock. Overlaying that with momentum factors and with volatility factors. We’re looking at, at Franklin Templeton, fundamentally we are an active house with fantastic research driven fundamental stock picking capabilities. So when we look at the multi factor smart beta, we take that decades of expertise in active management and we believe that those insights can be put into a rules based index product in an ETF form.
Beverly Chandler
OK. So another area that we hear a lot about with the ETFs, and in fact in investment generally, is the rise of sustainable investment using environmental, social and governance: the ESG filters. These are increasingly important to investors, obviously. How can ETFs help them achieve investment in those fields?
Jason Xavier
Absolutely. We're seeing more and more investors utilise these products to not just be a satellite of what they're doing. This is this is really coming into the call. And so we're seeing a lot of investors now look at options, be it either, as we said through passive or through a sort of alternative index smart beta approach or even an active approach to invest in sustainable, sustainable initiatives. I suppose the key the key here really is to to educate investors on the distinction between the two different kind of categories that we have. We have ETFs that you may hear that are that have an Article 8 disclosure on them, Article 8 funds and Article 8 ETFs effectively promote environmental and social characteristics, OK? So there's a promotion there, there's something in those in those portfolios and those stocks that are looking to help with the transition to a green economy. It could just be a revenue stream that comes from some research and development, but it's not at their core those, those those stocks are not, you know, solely doing something in that sustainable space. You might then hear about ETFs that have an Article 9 categorization and those are really ETFs that have sustainable investments at the core of their objective, OK? And Article 9 as an example, if you look at sort of green bond portfolios, green bonds are a fantastic way to get help in the transition to a green economy and they are Article 9 because every bond that's issued is tagged to a green project. It could be a solar farm, it could be debt that's issued for a solar farm or wind farm, or whatever it may be. They are directly contributing to that transition. So it's worth the investors appreciating the difference between, you know, Article 8 and Article 9, and understanding, you know, what ETFs, what the different ETFs are out there and using those for the outcome that they're looking to achieve.
Beverly Chandler
And so we've looked at a range there that, sort of what I'm calling the flavours of ETFs. How can you, how can an investor put those together to create a portfolio that meets their needs, that can, because you talked about tilting and almost like you can dial up, dial down. How can that work in a portfolio?
Jason Xavier
Absolutely. So, so again, at Franklin Templeton we believe that you have beta shouldn't break the bank and you have active at the other side. And we believe that in the middle you have, you know, alternative indexing, outcome orientated solutions. So depending on what your objective is as as an individual investor it could be to have a core and follow the market, but bolt on to that some alternative indexing cause you want a yield enhancement or you want to get some extra dividends. Couple that with some active. So understanding the different ETFs and understanding what your objective is, there's an ETF to help you help you there. You know, you could then say that I want to overweight a particular country or I'm I'm a global investor, I want to invest in a global portfolio but I want to overweight with a with a particular country; I have a particular view on India as an example. Well, you know, there's a single country ETF out there that can give you that overweight. Depending on your view, you may want to then say well I I want to do that but I also think that there's there's a good opportunity to get more dividends in a particular country, you know, European dividends, I want to overweight dividends in this period. Again, so depending on your objectives there's an ETF to help you. And there's multiple ETFs that can help you then build a kind of model portfolio for yourself to then manage your own your own objectives and your own goals effectively.
Beverly Chandler
And you could also manage them for whether or not you want to increase your income or your capital growth or.
Jason Xavier
Exactly. So whether you're looking for growth, whether you're looking for income, you could use them through a liquidity sleeve. We've spoken about that before where again, you may have your core holding and then you may say, well, I want to increase, I want to dial it up, dial it down, I have a view. Well, I'll use the ETF because I can get that intraday flexibility. I know that there might be there's a budget announcement this week, I might want to, you know, invest more in this particular region as a result or whatever's going on. You can use the ETF wrapper to take advantage of that intraday that liquidity profile and use the product as a liquidity sleeve. We see a lot of people doing that now. You can use it as a cash proxy, we see a lot of people using ETFs as a cash proxy for short short duration or short short term cash management, treasury departments do that. So again, depending it really you've gotta start with what my what my objective is and then, you know, there's there's a there's a an array of sort of methods and ETFs out there to help you reach that objective.
Beverly Chandler
Thank you. Thank you so much Jason for your time today and for explaining all of those things. We've discussed the many varieties of ETFs and how they can work for investors. Thank you to you for listening to this episode of Off the Record, a podcast from ETF Express brought to you in partnership with Franklin Templeton.
Outro
Off the Record is brought to you by ETF express. Production by Imogen Rostron and Lisa Hines and music by Otto Balfour. Thank you to our guests on this episode of Off the Record from ETF Express and to you for listening. We look forward to you joining us next time.