ETF Watch: First Trust Has Busy Day

Today First Trust is rolling out seven ETFs, six on the Nasdaq exchange and another on the NYSE Arca.

The first batch includes six smart-beta funds offering a risk-focused multifactor approach. Those ETFs, their tickers and expense ratios are as follows:

• First Trust Developed International Equity Select ETF (RNDM), 0.65%
• First Trust Emerging Markets Equity Select ETF (RNEM), 0.77%
• First Trust Large Cap US Equity Select ETF (RNLC), 0.60%
• First Trust Mid Cap US Equity Select ETF (RNMC), 0.60%
• First Trust Small Cap US Equity Select ETF (RNSC), 0.60%
• First Trust US Equity Dividend Select ETF (RNDV), 0.50%

Meanwhile, the First Trust California Municipal High Income ETF (FCAL) comes with an expense ratio of 0.50%.

A Smart-Beta Family
The benchmarks for the six smart-beta funds are derived from plain-vanilla benchmarks maintained by Nasdaq.

According to Ryan Issakainen, senior vice president and ETF strategist at First Trust, the key features of these funds are their neutral approaches to sector and, in the case of the international funds, country, which are uncommon among volatility- and dividend-focused strategies.

The two internationally focused ETFs, RNDM and RNEM, both track indexes that maintain the sector weights of the parent benchmarks and rank the securities in those benchmarks by trailing 12-month volatility relative to the other stocks in the same country.

Methodologies

From there, the methodology selects the 25 stocks with the lowest volatility for each country. If a country has fewer than 25 securities, all of its securities are included in the index. Finally, the securities within each sector are equally weighted.

The U.S. ETFs—RNLC, RNMC and RNSC—are focused more on dividends than on volatility. Each includes only companies from the parent benchmark that have paid a dividend in the trailing 12 months. The parent benchmark’s sector weights are maintained, with individual components equal-weighted within their respective sectors.

Finally, RNDV follows a similar methodology to the other U.S. ETFs, but it additionally screens out stocks that have a dividend yield higher than the parent benchmark’s yield. It also weights companies by dividend yield rather than equal-weighting them.

Issakainen says that the strategies in the Select family are focused on quality and low volatility. He adds that in international markets, and especially in Europe, dividends are viewed somewhat differently and are driven more by profits. As a result, a dividend cut by a foreign company does not have quite the implications of a dividend cut by a U.S. company. For that reason, the methodologies of the non-U.S. funds focus on volatility, while the U.S. funds focus on dividends. 

Issakainen further notes that the funds’ indexes were developed with Riskalyze, a firm focused on helping advisors correctly assess and accommodate its clients’ risk tolerance. The funds will be included in some of Riskalyze’s model portfolios.

Active Muni Fund
FCAL is remarkable because it covers the California municipal bond market via an active strategy. Both the existing ETFs covering California’s municipal bonds are index-based. The PowerShares California AMT-Free Municipal Bond Portfolio (PWZ) and the iShares California Muni Bond ETF (CMF) have $184 million and $762 million, respectively.

With California the most populous state in the union—and heavily taxed, to boot—“there’s certainly a large number of people whom we think would generate demand for this sort of product,” Issakainen said. In general, with municipal bonds, only the residents of an issuing state can see the full tax benefits.

The new fund can invest in California’s municipal securities, as well as in those of U.S. territories such as Puerto Rico, the U.S. Virgin Islands and Guam. The types of securities can range from municipal lease obligations to inverse floating-rate securities and include everything in between.

Although the fund is expected to have a weighted average maturity of 14 years or less, it can invest in securities of any duration or maturity. At least 50% of the portfolio must be rated investment-grade when it is added to the fund, and those rated as less than investment-grade securities at the time of addition must represent no more than 50% of the portfolio, the prospectus said.

‘Value-Add Opportunities’

“Because it’s actively managed, we’re comfortable allowing there to be more below-investment-grade bonds in the portfolio,” Issakainen noted. “We can do credit analysis and evaluate the ability of the borrowers to service and repay their debts, and we think there are opportunities to add value.”

He further notes that the team managing the fund has a long history and extensive experience in the municipal bond space.

Contact Heather Bell at [email protected].