John Hancock Launches ETF ‘Business’

John Hancock, which has $80 billion of mutual funds in assets under management and has been flirting with ETFs via various filings since 2009, launched its first six funds this week. The underlying index methodology, developed by Dimensional Fund Advisors, overweights holdings based on smaller size, higher relative profitability and lower relative price. ETF.com spoke with Andrew Arnott, the company’s chief executive officer, about the new funds and how he sees this as much more than a product launch, but rather a new business launch.

ETF.com: Let's first talk about the funds you launched this week. You're working with Dimensional Fund Advisors on this, which is also its first foray into ETFs. How did that come about?

Andrew Arnott: Our model is a manager-of-managers model and dates back to 1998. The idea is very investor-centric: Identify investor needs; go around the world to find the best manager we can for whatever we're trying to offer investors. That approach back in 2006 created a relationship with DFA. It was a relationship where we wanted to get exposure to its capabilities in small-cap and emerging markets inside our asset allocation funds.

It's been a wonderful relationship. It’s done a great job for our investors. And when we decided we wanted to get into this space—and this is pretty typical of all of our product development exercises—we looked first at the stable of managers that we're doing business with today to try and find managers that might fit the bill, and that's how we started the discussion with DFA.

ETF.com: How many mutual funds did it work on for you before the ETFs?

Arnott: There are three individual funds that it was managing for us prior to these six ETFs that we just launched.

ETF.com: Talk a little bit about these multifactor ETFs you have launched.

Arnott: It's taking passive investing and applying a factor-based approach to it to produce a better outcome than traditional, commercial indexes. The indexes that are behind these ETFs were created from an investment philosophy that dates back 30 years with Eugene Fama and Ken French being the authors of the three-factor model. They're big players inside DFA. It's that empirical and academic research that is the engine behind these indexes.

The basic concept tries to identify those factors that can be isolated that lead to the potential for outperformance; in this case, overweighting toward smaller capitalization—not small-cap necessarily, but smaller-capitalization companies to companies with lower valuation price. Then the last factor is profitability, higher profitability.

For our multifactor large-cap fund, the opportunity set is 750-800 of the largest U.S.-listed companies. We apply those factors in a very rules-based approach to create the index, and then have the ETF follow that index.

ETF.com: I noticed there's a little bit of overlap on the midcap/large-cap in terms of size of companies.

Arnott: I don't think that's unusual when you have large- and midcap. Because think about this: If we're choosing from the largest 800, and you're going to try to overweight the smaller capitalization of the largest 800, that's going to take you more toward the smaller end of that spectrum, which could include some midcaps. That's why you have overlap there. And then even in the midcap space, you're going to have overweight to more of the smaller-capitalization midcaps. It's just a natural outcome of product construct.

ETF.com: What was the impetus to finally bring ETFs to market? Were you getting requests for it? Or do you now see ETFs as essential tools in investors’ kits?

Arnott: It was a recognition that this is a product concept that is very real; it's here to stay. These $2.5 trillion that've gone into ETFs in the U.S., $3 trillion globally, that's really just the beginning. The ETF concept in terms of the tax efficiency, the trading efficiency—those are real benefits for investors. It was a recognition that it is a very advantageous vessel for investors.

Secondly, the environment that we're in, in the U.S., has gone very much fee-based. The fee consideration is paramount today. There's a lot of pressure around fees, and that's going to continue. Investors, by virtue of that, in a fee-based environment, are going to demand more fee-sensitive products. ETFs are going to be supported by that factor also.

We don't fall victim to the discussion based on performance. Obviously, ETFs are benefiting from the fact that passive has outperformed active for a long period of time here. And that's probably driven a lot of the flow. But I think it was more a realization that some of our brethren in this industry look at this as a cyclical situation, and that maybe we're on the doorstop of active potentially outperforming passive because of the volatility we're seeing in the market.

It was kind of an epiphany in the sense that, while $2.5 trillion has gone into ETFs, even if active outperforms—or I should say, when active outperforms, because it will happen— $2.5 trillion isn't going out of passive back into active. Once investors start to subscribe to this religion, it's unlikely that they're going to break from it. Once you start paying 50 basis points for an exposure, or 35 basis points for an exposure, it's going to be really hard to go back to 100, 120 basis points for the core of your portfolio.

It's an exposure that makes sense, and ETFs are here to stay. In addition, investors are demanding it, and our model allows us to offer some really compelling solutions.

ETF.com: How's the distribution model going to work?

Arnott: We'll be leveraging all of our existing distribution. We have 85,000 financial advisors who have entrusted their clients' money with us, from all the major broker/dealers. All the firms that we've talked to have expressed interest and acceptance, and these funds will be available through them. They'll be available through all the major trading platforms where people buy and sell today.

I think that you'll see them used in some new markets, like where people are considering robo advisors; robo advisors use a lot of ETFs. We'll have exposure there in the future as well as ETF strategists, who I think will find our offerings compelling, along with high net worth clients and millennial investors in general.

There are a lot of different channels that we'll be able to go after, but out of the gate, we'll go with the network of 85,000 financial advisors that we're working with today that are already doing ETFs.

ETF.com: So not necessarily Schwab's platform, for instance, or TD Ameritrade's no-commission?

Arnott: We anticipate the funds will be on all those major platforms. I don't want to name one specifically, because we're in the process of setting up. But those types of supermarket platforms, we expect to be there.

ETF.com: I would presume you're planning more ETFs down the road. Will you continue working with DFA in the same manner?

Arnott: We can't speak to things that aren't filed yet or approved, but what I can say is that this is the beginning. We're coming into this market in a very meaningful way. We're not tiptoeing in and trying to see if it works out and decide from there. This is a real commitment to a new business. But it is a business. The expectation is that we'll continue to launch product in the future if we can find compelling opportunities to meet investor needs.

One thing that I've told our folks is, if we can't add value, then we shouldn't launch the product. So it'll be a very measured, meaningful and strategic approach. But our expectation is we'll continue to build this out as a business. We don't look at this as a product launch; we look at this as a new business launch.