[This article appears in our November 2018 issue of ETF Report.]
Late last year, the single-country ETF arena heated up, when Franklin Templeton Investments took the bold step of rolling out 16 plain-vanilla ETFs targeting individual countries and regions priced well below those of the iShares, the dominant country ETF family for more than two decades.
The iShares geographic ETFs are a juggernaut representing $66 billion in assets that encompass 64 single-country ETFs—that doesn’t even include the various regional funds. Many have been around for more than 20 years, as the first funds in the lineup rolled out in 1996.
Other issuers have sought to challenge iShares’ dominance in the space, but none has succeeded. So what makes Franklin Templeton think it can be different?
“Because frankly, we think beta should be cheap,” said Patrick O’Connor, Franklin’s global head of ETFs, who previously worked for BlackRock’s iShares unit.
Facing Off With iShares
Northern Trust—in its first foray into ETFs back in 2008—rolled out roughly 20 ETFs targeting different foreign markets and tracking local indexes. Competitively priced, they were met with a great deal of excitement, but not assets. The NETS country ETFs closed about a year after the first ones launched. The firm would not return to the ETF space for another two years.
Franklin was far more aggressive than Northern Trust with its plans. For one thing, it went with indexes supplied by FTSE Russell, one of MSCI’s primary competitors. MSCI indexes underlie most of the iShares country funds.
Further, Franklin’s first batch of ETFs featured developed-market ETFs that charged only 0.09%, and emerging market funds that charged 0.19%. Some cost less than a quarter of the expense ratio charged by their corresponding iShares fund.
“This particular space had one competitor,” said O’Connor. “There’s a lot of room for the Franklin LibertyShares passive lineup to grow, and we expect to participate in that, especially at the price point that we’re bringing it out at.”
Investors Driving Demand
Dina Ting, senior vice president and portfolio manager overseeing Franklin’s passively managed ETFs, notes that bringing out country ETFs really is only going to work for an issuer if it offers a complete lineup. Investors are getting more precise in their international focus, she says, and they tend to use models based on country allocations rather than regional allocations.
“Customers are demanding more precise exposure,” Ting said, “and they’re going to look for a low-cost product to do it.” Like O’Connor, she previously worked for iShares.
And slowly but surely, Franklin’s strategy is paying off. The Franklin FTSE Japan ETF (FLJP) is the firm’s third-largest ETF, at $244 million. Another five country and regional ETFs fall into Franklin’s top 10 ETFs by assets (Figure 1).
The country/regional family has since grown to include 23 ETFs, many of which have just a few million in assets; in all, the family represents more than half of the 39 ETFs offered by the firm. Franklin has quite clearly staked out an area where it hopes to compete.
A Giant Starting Small
But the one thing that makes Franklin stand out in this space is its size. Franklin Templeton is a giant in the mutual fund industry, with more than $717 billion in assets under management. Though ETFs, at $1.6 billion of Franklin’s assets, comprise just 0.2% of Franklin’s total assets, it has the financial muscle to bide its time and grow assets.
The firm launched its first ETF in 2013, the Franklin Liberty Short Duration U.S. Government ETF (FTSD), an actively managed ETF that focuses on short-term U.S. government debt. Today FTSD has $175 million in assets under management.
Franklin’s next ETFs didn’t roll out until well over two years later, after it had hired O’Connor as global head of ETFs. To build out the firm’s ETF business, O’Connor brought in former iShares colleagues, including David Mann, an expert in capital markets and execution services, and Ting.
The firm seemed to yoke the abilities and experience of its new hires with its own core competencies. Franklin would use mostly index strategies for its equity offerings and active management for its fixed-income ETFs. It would leverage is reputation for active management in ETFs and look to compete in the smart-beta space, focusing on factor-based equity funds.
Smart Beta With ‘Specific Outcomes’
In 2015, Franklin debuted the first of its LibertyQ multifactor equity family, which quickly gained traction with investors. In fact, two of the LibertyQ multifactor ETFs are Franklin’s largest funds—the $365 million Franklin LibertyQ U.S. Equity ETF (FLQL) and the $280 million Franklin LibertyQ Emerging Markets ETF (FLQE) (Figure 2).
The methodology underlying each of those funds targets the quality, value, momentum and low-volatility factors. Both have kept up with, and often outperformed, competing funds and comparable cap-weighted products.
According to Ting, the portfolio manager for Franklin’s passively managed ETFs, the firm’s smart-beta lineup is about “trying to lower risk while achieving higher returns,” she said.
Ting notes that Franklin’s methodology is unique from many other multifactor ETFs, in that it doesn’t equally weight the importance of the different factors. Quality is weighted at 50%, with value at 30%, and momentum and low volatility at 10% each. According to Franklin Templeton, this feature of the methodology reflects the company’s approach to active equity investing that guides its stockpicking.