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Taste for ‘smarter’ funds kicks passives into shape

by Emma Dunkley on Dec 28, 2012 at 07:00

Another form of innovative product type stems from the way in which the underlying indices are constructed and adapted on an ongoing basis. IShares, for example, announced it would cap its high-yield bond fund to ensure investors are not overly exposed to certain countries amid the eurozone crisis. The issuer put a 20% cap on country weightings to prevent investors ending up with significant exposure to, for example, a country such as Spain if their bonds get junked.

IShares also placed tighter caps on the exposure to individual issuers, lowering it from 5% to 3% to mitigate concentration risk. ‘In high yield, we are putting caps and constraints on the raw index. We want to make sure we do not get an oversized position in some companies,’ says Alex Claringbull, senior fixed income portfolio manager at iShares.

The move should allay investor fears that the ongoing eurozone debt crisis, which has recently been alleviated by the European Central Bank’s bond-buying proposal, could result in a number of bonds being junked and indices overexposed to certain indebted countries as a result.

If the cap fits

Wealth managers have also aired concerns regarding passives based on fixed income, in the view that cap-weighted benchmarks leave them invested in indebted companies. ‘It’s not always the case that fixed income products leave you with exposure to the most indebted countries or companies,’ says Claringbull,
who cites the changes in the high-yield ETF as an example.

He says: ‘We carefully construct the underlying indexes to ensure liquidity, among other factors. For example, if Vodafone has 15 bonds, iShare selects the ones based on relative value and liquidity, for example. The fund is managed based on sampling rather than full replication.

‘Also, people say they don’t want a product that is overweight Italy and Spain. We think it’s changing so that the eurozone isn’t homogenous and investors are looking at individual countries. So we have launched individual country ETFs, for example, Italian government debt – the investor is in control.’

Indeed, issuers have started to address investor concerns about fixed income-based ETFs by launching products that track alternatively weighted benchmarks. At the same time, alternatively weighted indices are also gaining traction in the equity space as a way of gaining ‘smarter’ exposure to underlying markets.

Earlier in the year, Source launched an ETF designed to provide value-focused exposure to the European equity market. The MSCI Europe Value Source ETF is designed to give investors a European value strategy by tracking a diversified index while offering intraday liquidity.

The underlying MSCI Europe Value EUR Total Return (net) index is a subset of the MSCI Europe benchmark and focuses on stocks that show value as opposed to growth.

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