Freedom Weighted ETF Debuts

May 23, 2019

Inside, A Sector Shake-Up

Without China, FRDM's index performance naturally will deviate from that of other emerging market funds. But it shouldn't stray too far, says Tolle, as high allocations to Taiwan and South Korea—countries whose performance is highly correlated to China—will act as a China proxy for the time being.

"They give us low tracking error to other emerging market benchmarks, but without the China exposure," she said.

On the other hand, FRDM's sector makeup differs significantly from other popular emerging market ETFs, which include SOEs and stocks from commodity-rich nations.

For example, FRDM has nearly twice the allocation to information technology companies as EEM, yet a substantially smaller allocation to industrials, energy firms, and consumer discretionary and staples stocks.

 

Top 10 Sector Weights, By Percentage
EEM   FRDM
Financials 24.06%   Information Technology 26.59%
Information Technology 14.52%   Financials 24.35%
Consumer Discretionary 13.36%   Consumer Discretionary 12.00%
Communication 12.24%   Materials 9.82%
Energy 8.06%   Communication Services 8.54%
Materials 7.33%   Energy 5.71%
Consumer Staples 6.39%   Consumer Staples 5.69%
Industrials 5.35%   Industrials 2.99%
Real Estate 3.14%   Real Estate 2.16%
Health Care 2.64%   Healthcare 2.14%

Sources: BlackRock, Life + Liberty Indexes. Data as of May 22, 2019.

 

Eliminating ‘The Worst Actors’

Each January, the Life + Liberty Freedom 100 Emerging Markets Index is rebalanced and reconstituted, meaning FRDM's country mix can and will shift.

For example, Poland once held top weighting in the index; after right-wing extremists assumed power, however, the country fell from first ranking to fourth.

A rebalance may also be triggered after significant geopolitical events. Should a constituent country decline a certain number of percentage points on a "freedom health" scale, that nation is dropped from the index immediately—as was the case in 2018, when President Erdogan's consolidation of power led to Turkey being dropped from the index.

Ultimately, however, some countries with less free markets may still make it into the index. That's because there is no 100% "free" emerging market—just as there aren't any 100% "free" developing markets. The Life + Liberty benchmark simply strives to find the most free countries, and barring that, the least worst options.

"We're not drawing a firm line in the sand," said Tolle. "Instead, we're trying to eliminate the worst actors."

ETF By ‘True Believers’

Unlike many ESG products these days, which have been rushed to market to capitalize on investors' growing consciences, FRDM seems like it has been built by true believers. That's because it was.

Before founding Life + Liberty Indexes, Tolle lived and worked in Beijing, Shanghai and Hong Kong, where she got to see firsthand the difference freedom makes to an economy and the people participating in it.

She translated the lessons learned into the development of the Life + Liberty Freedom 100 Emerging Markets Index, which underpins FRDM.

Believing Is Investing

The ETF represents Alpha Architect's first partnership with a third-party index provider, as well as its first foray into socially responsible investing. The firm already has five other ETFs under its belt, the largest of which is the $92 million Alpha Architect Value Momentum Trend ETF (VMOT).

In FRDM's case, however, the firm is taking a back seat role, essentially acting as a white label ETF provider, while Tolle serves as the "face and the brand" of the ETF, says Gray.

"We're not going to turn into a front-and-center ESG firm," he added. 

Still, Gray admits FRDM speaks to him on a personal level. As a former U.S. Marine, whose firm employs a substantial number of military veterans, Gray was drawn to the concept of freedom weighting as a real-world application of the principles for which he put his life on the line.

"People want to do business with people they believe in," he said. "I don't see the corporate, soulless brand of [a big ETF company] convincing investors that they truly believe in their ESG funds; to them, it's just another product. Given the choice, I think people will want to do business with a boutique firm that really believes in their products." 

Competitive Price, Good Timing

Whether investors actually will believe in FRDM's concept is yet to be seen. But FRDM does have one substantial advantage: its price tag.

The ETF has an expense ratio of 0.49%, well below the cost of the average emerging market ETF, which costs 0.60%. Meanwhile, the average socially responsible ETF costs 0.41%.

Another advantage is one of timing. As major indexers like MSCI increase their Chinese A-shares exposure and add Saudi Arabia to their benchmarks, investors who don't want to invest in these countries are left with few options.

To them, FRDM might just be the right product at the right time.

Contact Lara Crigger at [email protected]

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