Freedom Weighted ETF Debuts

May 23, 2019

In the increasingly “greenwashed” field of environmental, social and governance (ESG) ETFs, where more and more ETFs are principled in name only, the Freedom 100 Emerging Markets ETF (FRDM) truly stands apart.

The fund, which launches today on the Cboe Exchange, uses a first-of-its-kind "freedom weighted" methodology that selects and ranks countries based on the liberties their governments secure for their citizens. (Cboe Global Markets is the parent company of ETF.com.)

It's an idea backed by decades of research, which shows countries that treat their citizenry better also tend to possess healthier, more robust economies (read: "Human Freedoms Make Better Markets").

"Freer markets perform more sustainably, recover faster from economic drawdowns, and use their capital and labor more efficiently," explained Perth Tolle, founder of Life + Liberty Indexes, the sponsor and indexer for FRDM.

Freedom weighting "also makes intuitive sense," added Wes Gray, CEO of Alpha Architect, whose subsidiary, Empowered Funds, LLC serves as FRDM's investment advisor. "Countries with strong capital markets and plenty of economic and political freedom just seem to outperform over the long haul the countries that are going crazy."

How Freedom Weighting Works

To build FRDM's index, Life + Liberty first starts with a potential universe of 26 emerging market nations—including the usual players, such as China, Brazil, Russia and so on (read: "'Freedom' Based ESG ETF Coming").

From there, countries are evaluated on 79 personal and economic freedom indicators, based along three main themes: civil liberties ("life"), political freedoms ("liberty") and economic freedoms ("property").

Countries are evaluated on everything from the amount of violent conflict, torture and human trafficking within their borders; to the establishment of a free press and judicial independence; to the security of property rights and the existence of tariffs and capital controls.

A quantitative model is then used to rank and weight countries by their freedom levels; the 10 countries with the highest freedom levels are selected for inclusion in the index. (That differs from most emerging markets and ESG funds, which select and rank constituents on a security level, rather than on the country level.)

Finally, the top 10 largest securities in each country are selected and weighted based on their market capitalizations and certain liquidity thresholds. State-owned enterprises (SOEs) are excluded from the mix.

Emerging Market ETF Without China?

This methodology results in an emerging market ETF that's vastly different under the hood from competing funds. China, Brazil, Russia, Saudi Arabia and many other developing nations with corrupt or authoritarian governments are nowhere to be found inside FRDM.

In fact, out of more than 220 emerging market ETFs, FRDM is the only one not to allocate to China, without specifically being designed for that purpose.

This is to say, several ETFs explicitly exclude China from their investment universe: the Columbia Beyond BRICs ETF (BBRC); the iShares MSCI Emerging Markets ex China ETF (EMXC); and the Columbia EM Core ex-China ETF (XCEM), among others. But until now, there has never been an emerging market ETF that could include China but that chose not to.

Instead, the highest-weighted country in FRDM is Taiwan, at 23%; followed by South Korea, at 18%; and Poland, at 15%. (Compare that to the iShares MSCI Emerging Markets ETF (EEM), which holds 33% of its portfolio in China.)

 

Top 10 Country Weights, By Percentage
EEM   FRDM
Country % Weight   Country % Weight
China 31.9%   Taiwan 23.3%
South Korea 12.6%   South Korea 17.4%
Taiwan 11.5%   Poland 15.0%
India 9.7%   Chile 14.8%
Brazil 7.2%   South Africa 9.0%
South Africa 6.2%   Philippines 6.3%
Russia 4.2%   Mexico 5.8%
Mexico 2.8%   Indonesia 4.0%
Thailand 2.4%   Thailand 3.3%
Malaysia 2.2%   India 1.1%

Sources: ETF.com, Life + Liberty Indexes. Data as of May 20, 2019.

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