ETF Watch: Legg Mason Launches Emerging Market Fund

Today Legg Mason is rolling out an ETF on Bats that targets the emerging market space using the same basic low-volatility, high-dividend methodology the firm has introduced in two other funds. The Legg Mason Emerging Markets Low Volatility High Dividend ETF (LVHE) completes a three-fund suite and comes with an expense ratio of 0.50%.

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Problems To Solve

“When we come up with equity solutions, a lot of times it’s because we see a problem. When we came up with the low-vol, high-div series, it was really to solve two things. One was the challenge of getting income in this market, which in the last seven years has been really hard,” said Mike LaBella, a portfolio manager with Legg Mason subsidiary QS Investors.

The other problem to be solved was economic anxiety, he noted.

“A lot of our clients really have had to hold on to equities longer than they thought; people are living longer; return expectations on fixed income are pretty low. We just finished this 30-year bull market where bonds rallied for 30 years, and now we’re just sitting at this bottom where yields have nowhere to go but up. That means investors have to hold more equity, and that comes with a lot of risk,” LaBella added.

Such investors tend to be very sensitive to volatility, but in searching for income and holding more equities, many people did not focus on the additional risk they were taking on because of that, he noted.

“If they’re in a decumulation phase, they easily can draw past their income and right into their principal, which can force them into a sell-low/hold-high investment strategy, which is not exactly a key to succss. We call that ‘dollar-cost ravaging,'” LaBella said.

Index Construction

LVHE’s underlying index is derived from the MSCI Emerging Markets IMI Index, and looks to target the components of that selection universe offering above-average dividend yields and below-average earnings volatility and price volatility. Volatility and dividend yield are also used to adjust the weightings of the individual securities, according to the prospectus.

The earnings volatility evaluation is fairly unique, according to LaBella.

“We want to make sure that the companies in this portfolio have predictable earnings. We want to make sure they have established business models, that they’re a bit more mature, that they will be able to continue to service that high dividend that they’re paying,” he added.

In keeping with LVHE’s low-volatility objective, the index also hedges away currency risk, which LaBella says is a strategic, not a tactical, decision. And in the interests of quality, the index methodology screens out stocks that have not been profitable for the preceding four fiscal quarters in aggregate.

“There’s an enormous amount of companies out there, which, over the years, have been increasing their dividend, but their earnings haven’t been increasing along with it. That means their payout ratios have been rising significantly, and many of them have risen way over 100%, which means they’re paying out more in dividends than they’re seeing in profitability and earnings. We don’t want any of that,” LaBella said.

Components
LVHE’s index also has diversification-based weighting requirements that limit the influence of any single security, country, region or sector, the prospectus noted. Ultimately, LaBella says, the index includes some 70 to 120 names.

Sometimes they aren’t always the names you’d expect. LaBella notes that energy companies are well-known for their high dividends, but points out that the earnings in the energy space crashed a few years ago. However, their dividends have continued to grow. As a result, such companies do not tend to make it into the indexes, and the U.S. index does not include any energy companies.

In general, LaBella describes the portfolio as one with a high yield, but relatively low market beta. As a result, it will capture a bit less upside when the markets are rising but offer more protection when markets turn downward, he said.

Legg Mason rolled out its U.S.-focused Legg Mason Low Volatility High Dividend ETF (LVHD) at the end of 2015, and the fund has since accumulated some $98 million in assets under management. The developed-market Legg Mason International Low Volatility High Dividend ETF (LVHI) launched in July and has about $3 million in assets under management.

“This is really rounding out the suite that we started launching back in December 2015,” LaBella said in reference to LVHE’s launch.

Contact Heather Bell at [email protected].