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How Rathbones is using smart beta

by Emma Dunkley on May 24, 2012 at 14:12

Elizabeth Savage, research director at Rathbones, discusses how the firm uses structured products and the main points to consider when selecting exchange traded funds (ETFs).

What type of beta products do you use and why?

We use structured products and ETFs as smart beta plays. Structured products are a useful way to access  beta, while incorporating attractive risk asymmetry.

For example, one can buy a structured product that offers participation in the rise of the FTSE 100 index while preserving capital in the event of a decline in that index.

ETFs are used to invest in highly efficient markets where active managers struggle to outperform – one example is the US equity market. ETFs also offer access to markets that are difficult to invest in directly, owing to structural reasons.

For example, many investors find it impractical and expensive to take physical delivery of a physical commodity, and therefore physically backed ETFs provide a neat solution to such a problem, where storage costs are pooled and economies of scale can be achieved.

ETFs can also be used for tactical purposes when an investor wants to change their asset allocation quickly and at a low cost.  

How do you choose the type of beta products to implement your views?

For ETFs, the main consideration is cost efficiency and liquidity. If the ETF is more expensive than an active manager, then it is unlikely to be attractive to us. It might sound like an obvious point, but for beta one products, a low tracking error is very important.

The vehicle must also have a robust structure. In this context, we look at a range of factors such as replication methodology; whether there is a swap counterparty; collateral arrangements; stock-lending policies; and tax treatment, to name a few.

With structured products, we conduct thorough due diligence on the platform, as well as wrapper and counterparty credit risk.

We also determine whether the risk/return profile of a particular product is expected to fulfil our investment objectives, not only at maturity, but throughout its life.

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