Inside FlexShares ETF Strategy: Value, Inflation, And Dividends

By ETFDatabase | November 15, 2012 AAA

ETF issuers, both big and small, have taken great strides in democratizing the investing process, opening up the doors topreviouslyhard-to-reach asset classes. The uncertain economicenvironment, at home and abroad,however, has promoted some issuers to hold off from launching new products, while others have taken the opportunity to tap into more strategic corners. FlexShares, operated by Chicago-based Northern Trust, is one such issuer which continues to debut versatile offerings that may appeal to long-term investors in any economic environment. Shundrawn Thomas, Managing Director and Global Head of the Exchange-Traded Funds Group at Northern Trust, recently took time to discuss the various themes unifying the FlexShares products as well as his firm's vision moving forward.

ETF Database (ETFdb):How have you guys been so successful, especially in such a tough environment?

Shundrawn Thomas (ST):Context is important. If we look back at 2005 there were 8 U.S. ETF sponsors and today there are nearly 50. I think people have lost sight of the first 10 to 12 years of the industry. We experienced a time with relatively exponential growth with few competitors and subsequently have entered a period of more intense competition. In that regard we expected more fund closures. We are very circumspect with respect to our early success and need to build on our strengths to keep it going.

We are focused on our value proposition and our products; we target investors that are using ETFs in a more strategic portfolio context. Given who we are, wearen'tprincipally focused on trading oriented or pure beta strategies which are saturated markets. We launch distinctive products and take the time to let them get seasoned in the market. Some feel that this doesn't apply due to dynamic market growth, but that's not true. Even if you think you have a good approach, you have to allow the market to provide feedback. This is why we have been deliberate about the pace of product introductions. So far, investors have appreciated our efforts and see that we are serious and are here to stay.

ETFdb: You have a lot of products that are very different, what would you say is a unifying feature in your product line-up?

ST:We began by developing an investment solutions framework that focuses on what investors are really looking to achieve. We find that they principally want to grow assets, mitigate risk, generate income, and maintain liquidity. We focus on these four objectives, leveraging our insights from investors and our investment expertise to offer distinctive products. As we add new products it becomes more clear what we are trying to achieve with our products and our overall value proposition.

ETFdb:Can you explain how your ETFs protect against inflation and how they distinguish themselves from the crowd?

ST: There are a number of competitor products, even beyond ETFs, that offer inflation protection. While investors consider the threat of inflation, people haven't expressed much concern until recently. Instead they havebenefitedfrom an environment that has produced modest headline inflation. When we talk to investors about investment options to hedge inflation, common views are not always supported by empirical evidence. If you look at gold for example, many investors consider it a preferred hedge for inflation.

In practice there are much better alternatives to hedge inflation. People don't always see it that way. TIPS are another example, as investors often pay little attention to the duration of their TIPS portfolios. The interest rate sensitivity of a TIPS portfolio can easily overwhelm the inflation hedging benefit if the duration is not considered and managed. We offer funds that precisely target the duration of a TIPS portfolio which has really resonated with investors. A lot of TIPS investors were not focused on the duration impact and appreciate the added protection and thought leadership .

ETFdb - What areas of the market will you be focusing on next?

ST:We are looking at a couple trends that we think will be important and persistent in the future. The first is the interest rate environment. The position of the Fed suggests that low interest rates will persist for a while. Investors in search of yield or income have faced this challenge for some time and it becomes more acute with changing demographics. If you are really investor centric, issuers have to address the need. We see a number of opportunities to address the objective of generating income in the current environment. Recall this one of the four fundamental objectives from our investment solutions framework.

Market structure and regulatory changes have affected market liquidity in a pronounced way. For example, investment banking firms are holding about a quarter of the trading inventory that they used to carry prior to the 2008 crisis. If you manage large portfolios, these changes impact how quickly you can get in and out of positions, particularly in the fixed income market. While this presents challenges, it also presents opportunities for thoughtful investment products that may invest in less liquid securities.

We have also been looking at equity valuations - the US market has done rather well this year, while both developed and emerging markets have not performed as well and trade at comparatively low valuations. As long term investors, we look at global economic trends and believe there is significant opportunity to invest in fast growing regions of the world and growth oriented companies that are exposed globally. There are also opportunities to do this in differentiated ways .

Finally, we believe investors need to think about a segmented approach to cash management, where they will need to consider trade-offs among safety, yield and liquidity. Our recently launched FlexShares Ready Access Variable Income ETF (RAVI) is an example of how we are responding to investor needs. This actively managed short duration fund provides both liquidity and competitive yield and is a distinct approach to many traditional cash management products.

Bottom Line:Looming economicuncertaintiesamid a low-rate environment pose challenges for investors and ETF issuers alike. On the product development front, issuers continue to respond to investors' needs as seen with the latest wave of income-focused ETFs. While the market's future may be unclear, investors are sure to benefit from the ongoing evolution of the ETF industry as more and more offerings become readilyavailable, while growing cost-competitionamong issuers will further benefit end-users.

Follow me on Twitter@SBojinov

Disclosure: No positions at time of writing.

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