From the April 2012 issue of Research Magazine • Subscribe!

From Backstage to Spotlight

Russell Investments is a familiar name to financial professionals everywhere. Its indexes are the guts and soul of many popular ETFs, and $3.9 trillion in investment assets are benchmarked to its indexes globally.

The Russell 3000, which covers roughly 99% of the U.S. stock market, is among the Tacoma, Wash.-based firm’s expanding product menu. Derived from the Russell 3000 are subsets like the Russell 1000 and 2000 that are linked to narrower segments of the equity universe like large cap and small cap stocks.

In addition to offering traditional market cap weighted benchmarks, Russell also offers indexes that use equal, dividend, fundamental and factor weightings. ETFs linked to these types of strategy indexes can be used for the core of an investment portfolio or to complement an investment allocation built around plain vanilla index funds. 

In 2011, the firm introduced its own lineup of Russell-branded ETFs, giving it a unique perspective as both an index provider and investment manager. And while Russell remains a pioneer in the evolving index world, by creating indexes that expand beyond traditional beta, it’s already carved out for itself an impressive place as an ETF provider. 

To learn more about what lies ahead for the ETF marketplace and Russell, we talked with David Koenig, CFA and director of investment strategy for Russell ETFs.

The low interest rate environment has more investors digging for income and the Russell Equity Income ETF (EQIN) could be the ticket. What’s the fund’s strategy?

The Russell Equity Income ETF (EQIN) is one of a family of 10 Investment Discipline ETFs built on the foundation of Russell’s more than 40 years of experience analyzing the behavior of professional investment managers. Each Investment Discipline ETF is designed to track a corresponding rules-based Russell Discipline Index that focuses on a unique set of characteristics specific to its targeted discipline.

With a total expense ratio of 0.37%, EQIN is designed to provide a new,cost-effective way to access a total return investment approach. This ETF focuses on a codified set of yield and quality characteristics typically targeted by equity income managers. It invests in companies that have historically paid dividends and exhibit traits which support the potential sustainability of the dividend, such as low earnings variability. Quarterly rebalancing helps maintain exposure to the targeted equity income characteristics, and sector and individual security limits help ensure diversification.

 Russell offers ETFs that target beta and volatility. What types of investors might these products appeal to?

Russell Factor ETFs are a series of 13 U.S. and international equity ETFs focused on individual risk factors such as beta, volatility and momentum. The new indexes for these ETFs are based on familiar Russell large cap and small cap indexes and focus on the subset of index constituents that exhibit high beta, low beta, high volatility or low volatility. These ETFs provide an efficient, cost-effective new way to target distinct factor exposures, help manage risk and potentially enhance diversification.

With Russell Factor ETFs, investors have access to risk management strategies that had previously been available only to the largest, most sophisticated asset managers. Russell High and Low Volatility ETFs can be used to directly manage exposure to volatility within a portfolio and target potentially smoother equity performance over time. Russell High and Low Beta ETFs give investors the flexibility to directly manage their portfolio’s equity market sensitivity in a single trade.

 A number of broad market stock ETFs weight stocks by various value metrics. How is the Russell Low P/E ETF (LWPE) different?

The Russell Low P/E ETF (LWPE) is designed to provide access to a portfolio of stocks that exhibit the characteristics typically targeted by professional investment managers who practice a low P/E investment discipline. The criteria emphasized within the underlying rules-based index include below-average valuation ratios based on multiple metrics, including earnings, cash flow, sales and book value.

In terms of weighting, Russell’s research has found that portfolios typically constructed by professional investment managers tend not to be purely market cap weighted. As such, the Russell Low P/E Index is constructed using a blend of 75% market cap and 25% equal weight to reflect the overall weighting characteristics typical of portfolios constructed by low P/E managers.

The traditional indexing camp stands behind market cap weighted benchmarks, whereas the fundamental indexing camp advocates alternative weighting methods. What does this mean for financial advisors who need to make a decision about which route to go?

There is room for more innovation in indexes and this has created a number of new opportunities for financial advisors and their clients. Whether it is alternative weighting methods or a variety of new index approaches, the important thing is for the advisor to understand these new indexes and how they work so he or she can help the client evaluate whether they may be a fit. The advisor should recognize that choosing a market cap weighted index strategy provides them with a market return while alternative weighting methods provide the opportunity for excess return. They need to decide whether they are comfortable achieving market returns (and potentially focusing their energy on other activities) or whether they believe they can provide additional value to their clients by trying to beat the market return.

 Are there any best practices or advice for financial advisors to consider before investing in ETFs linked to completely new or unfamiliar indexes?

With the growing number of ETFs in the marketplace, it is important for investors to understand each ETF’s underlying methodology. ETFs that may have similar names and similar strategies at first glance might have significantly different construction methodologies. These differences in investment universe, underlying index, construction criteria and level of transparency can result in meaningful differences in exposure and risk/return profile. At Russell, we believe in a fully transparent methodology so that investors have access to the information they need to help make informed investment decisions.

For example, many ETFs and actively managed mutual funds include “Equity Income” as part of their name and stated investment objective. Based on differences in how they’re constructed and managed, however, these funds may have very different performance patterns. A transparent, rules-based methodology, such as that used for the Russell Equity Income ETF (EQIN) seeks to provide focused, ongoing and transparent exposure.

 The ETF marketplace is still dominated by products linked to indexes. Do you see actively managed ETFs changing that?

Index-based ETFs are a powerful innovation that has helped reduce investment costs and democratize access to asset classes for all investors. These types of ETFs have grown rapidly in number and assets and should continue to be relevant for investors. A second generation of index-based ETFs is now entering the marketplace that moves beyond market cap weighted, pure beta exposures. These types of ETFs have been referred to as “intelligent beta” ETFs and provide new ways for investors to target focused exposures, help manage risk and potentially enhance diversification within their portfolios.

Russell believes that along with intelligent beta products such as Russell Investment Discipline ETFs and Russell Factor ETFs, active products are the next frontier in ETF development. Although actively managed ETFs are in their early stages of development, we believe that actively managed ETFs may play an increasingly important role in portfolio construction in coming years.

 Russell’s ETF lineup is mostly focused on equities. Looking ahead, is Russell planning to add other asset classes like bonds or commodities to the mix?

Russell has a long history of delivering innovative and relevant institutional-quality investment solutions based on its more than 75 years of experience and more than 25 years of index expertise. At Russell ETFs, we are constantly conducting research and evaluating new opportunities across all asset classes. We are committed to continuing to bring relevant new ETFs to the marketplace that can help investors construct well-defined portfolios based on their unique investment goals and tolerance for risk.

 What other major trends do you see in the ETF market?

Given the elevated volatility and low yield environment of recent years, two major issues investors face today are how to manage volatility and how to generate income. ETFs focused on risk-based solutions, such as Russell Factor ETFs, are a major development that can help investors more directly manage risk within their portfolios. ETFs focused on income in a total return context, such as the Russell Equity Income ETF, are another major development that can help investors seeking access to portfolios of high-quality, dividend-paying companies.

At Russell ETFs, we believe that intelligent beta ETFs such as Russell Factor ETFs and Russell Investment Discipline ETFs are a significant major trend in the ETF market today, and that actively managed ETFs may play an increasingly important role in the future. L

 

 

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