First Trust Marching To Its Own Drum

First Trust has 148 ETFs encompassing more than $89 billion in assets under management. The Illinois-based issuer holds a unique role in the ETF ecosystem as an independent company with a reputation for avoiding plain vanilla exposures. Here, Vice President and ETF Strategist Ryan Issakainen discusses what makes his firm stand out from the crowd.

How should investors look at the First Trust lineup?
At a very high level, when we create ETFs, we do it with the intention of the funds being used by investment professionals to generate alpha, to create better performance for their clients. And we do that primarily in three different groups.

The first is our actively managed lineup, which now has over $25 billion in assets. We’ve got over a 25% market share. And that ranges from fixed income, where we have the greatest concentration, as well as other strategies. But those are designed to primarily manage risk and deliver better performance for investors.

The second group includes a group of factor-based ETFs. That’s also an area where we’re seeking outperformance. Our factor-based lineup goes back over a decade and includes some of our largest and more popular funds.

Our third group includes things like thematic and narrow industries; areas that investors or investment professionals can target to overweight.

Would you talk about recent product launches at First Trust?
We have almost 150 ETFs now, so there’s a really high bar for us to introduce a new strategy. We’re constantly assessing areas where we think we can add value. We’re not interested in delivering another ETF that just replicates a broad benchmark. There’s really not any demand or need for that in the marketplace. But we are looking for areas where there’s a higher probability of outperformance—whether that’s active management or a factor strategy.

Some of our most recent launches were three ETFs focused on factors, but they’re also actively managed. That blends those two areas where, instead of factors in an index form or a smart beta approach, they’re a more active approach where we can address some of the nuances of factor investing, some of the risks, some of the overlap of factors and so forth.

Another new group of ETFs are our Target Outcome ETFs [which offer buffered exposure to the price performance of the SPDR S&P 500 ETF Trust (SPY)]. Those are taking the concepts that have traditionally been delivered in a structured product and launching them into an ETF.

But if you think about those concepts, they’re much different than where the ETF industry was 10 years ago. They’re new and innovative ways to create tools for advisors. I don’t know where the next great idea will be, but we’re constantly looking for it.

How do you decide whether to take an active approach to an asset class or to go with an index-based approach?
One of the ways we approach that is to look at the success that active managers are able to have or have had over long periods of time relative to their benchmarks and relative to passive managers.

For example, when we look at fixed income, there are studies that say active managers fail to outperform benchmarks in fixed income as well as equities. But when we look at fixed income and compare passive funds to active funds, the results are a bit different. Take, for example, high yield. In high yield, the research produced by S&P, the SPIVA scorecard, says that a really high percentage of high yield managers underperform the benchmark they have.

But when you look at performance of the average high yield index fund, compared to actively managed high yield funds, it’s a much different story. Those index funds didn’t deliver over the last five or 10 years anywhere near the returns of the actual index. We think that’s a better way to assess the probability of success for a category like high yield at a quantitative level.

We also look for ways that we can add value. Take the high yield or below-investment-grade credit, senior loans segments—do you have the ability through active management to better manage risk?

When we’re talking about below investment grade, that’s an area where we think you can better manage risk than an index, which simply allocates to its constituents based on how much debt they have outstanding. That doesn’t make sense from a risk management standpoint.

We look for where we can have a greater likelihood of success, where we have more tools to manage risk, and ultimately deliver better returns.

What led you to launch the Target Outcome ETFs?
We at First Trust, for a number of years now, distributed structured products for a number of different other vendors. Our team has really developed relationships and a high level of expertise in understanding those products. And those aren’t simple in the sense that many other funds are.

As we have built out our distribution capabilities in structured products, that helped lead to this approach within the ETF wrapper where we’re leveraging the expertise of our distribution capabilities. This structure is just another tool in the toolbox.

It’s not going to be right for everyone. But it’s a good way for investors to have a more certain outcome to manage risk if they believe the market has come too far and they want to protect some on the downside while still maintaining exposure to equities. Those are conversations we’ve had with advisors.

You have some interesting satellite-type funds. How do you decide what to launch in that space?
Some of our best ideas actually come from conversations we have with investment advisors, who are also doing research and trying to find ways to gain exposure to some of these disruptive technologies, some of these more innovative themes.

Our history with that sort of product dates back to some of our first funds. We launched our First Trust Dow Jones Internet Index Fund (FDN) back in 2006. We forget sometimes that, 10 years ago, that sort of investment wasn’t something people were clamoring for.

The holdings in FDN 10 years ago represented less than 2% of the S&P 500. Now they represent somewhere between 11-12%, because you had tremendous growth. But 10 years ago, you didn’t own those stocks by accident. If you wanted to participate fully in the growth of the internet as an investment theme, you had to allocate to something like FDN.

We’re looking for what the next FDN is. What’s the next theme that’s underrepresented in investors’ portfolios? One of my favorites is cybersecurity. The First Trust NASDAQ Cybersecurity ETF (CIBR) has quietly gathered $1.3 billion. When I look at how much representation the holdings in CIBR have compared to a broad index, it’s less than 2%. There’s a huge opportunity for growth with that as an investment theme, and that’s a good way to gain exposure to it.

We’re always looking for ideas. We want to be early to the game, if possible, as we were with cloud computing and other themes.