From the August 2012 issue of Investment Advisor • Subscribe!

Northern Trust Swoops Into ETFs

When you think of investing giant Northern Trust, you probably don’t think of exchange-traded funds, but that’s about to change. The firm launched FlexShares in the fourth quarter of 2011, and has already reached over $1 billion in assets. Part of its success is a focus on unique sectors and an “investor-focused framework.”

Shundrawn Thomas, head of Northern Trust’s exchange-traded funds group, took some time to explain FlexShares’ philosophy, and why taking on larger, established competitors isn’t as hard as one might think.

Why natural resources and TIPS; why those two sectors?

When we think about strategy, we think about our field as being very investor-centric. Most providers in the space have a product-centric focus. There’s nothing inherently wrong with that, but it’s more of a strategy that says, “Let’s look at the marketplace and see where there are product opportunities,” and then they develop products to fill that perceived market opportunity or need. Our approach is different. We say, “What are investors looking to achieve?”

“Tilted indexing” is something we haven’t heard of before. Please explain.

What you find in many investment portfolios is a core exposure to equities. We have developed an index-based fund that gives you core exposure to the U.S. market. But what we do with that portfolio is, while it gives you broad access to the overall market, we tilt it to exposure to small-cap and then also value. Think about it as pouring out exposure into a series of glasses. One of those glasses is marked “small-cap” and one is marked “value”—we’d pour a little bit more into those two glasses than the rest.

Let’s be honest—it sounds like a great story, but I think a lot of consumers would say, “Small-cap value, after what we just went through? Are they crazy?” How do you go up against something like that?

Historically, what you found is that you’ve been able to get a premium from an investment standpoint if you had exposure to small-capitalization stocks and value stocks. I think that’s what people will appreciate—it’s not that we’re saying “OK, we’re just giving you a small-capitalization portfolio,” or “We’re just giving you value stocks.” We’re not shifting the whole portfolio. It’s just a slightly higher weighting.

FlexShares are relatively new. How do you go up against the more established competitors?

There are a number of newer providers—whether it’s us or PIMCO or Schwab—that are having success. Too often, everybody looks at the big three, and they say “You’ve got these top three providers, and they’ve got 80% of the AUM. Understand that if the market goes up, they’ll just get new AUMs.” What I focus on is fund flows. I’ll give you one statistic: Last year, there were 18 exchange-traded funds that in their first year passed $100 million in assets. We launched in the last quarter of the year, effectively, and we had three of those funds. If you look through those 18 funds, only four of those funds came from those top three sponsors. My point is that when you start to look at what’s being introduced and how things are evolving in this space, we’re definitely seeing success from other players, from newer sponsors and from some boutique shops. It would be important for investors to understand that part of the evolution in the industry and not myopically focus on the folks with a lot of assets under management.

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