CoreShares is currently the only local manager that offers an ETF tracking the FTSE/JSE Equally Weighted Top 40 Index. This index is re-balanced every quarter to give each share in the Top 40 a weighting of 2.5% (for the purposes of this index, Investec plc and Investec Ltd are considered together, as are Mondi plc and Mondi Ltd).
However, CoreShares announced this week that it wants to replace this with an entirely different strategy. It wants to introduce a multi-factor index that will give investors exposure to six specific ‘market factors’ – value, positive momentum, mid-cap, low volatility, high profitability and low investment.
These factors can essentially be thought of as different investment styles.
“A retail investor might be more used to thinking about different managers who embrace different styles of investing,” explains Gareth Stobie, MD of CoreShares. “We are trying to capture those styles in a rules-based framework. So you could think of a multi-factor index as a multi-style approach. Instead of investing with a value manager or a quality manager, you are putting them together in one portfolio and letting the correlation benefits of that play out through time.”
Investing in just one style can often result in volatile performance. Value managers, for instance, might outperform over the long run, but they can underperform severely in the short term. By combining these factors, or styles, that volatility is reduced. At periods when value is underperforming, quality might be delivering returns, for instance.
CoreShares believes this is the most prudent approach to smart beta investing.
“If an investor’s goal is to move away from the market cap-weighted index and hold something different, we are going to put forward our best house view on how to do that,” Stobie says. “That is to hold all the factors alongside each other.”
A significant benefit of this approach is the attention it pays to managing risk, which is lacking in products that simply track a broad market index. This is a particular concern in South Africa where a few stocks make up such a large part of the index.
“The multi-factor strategy pays a lot of attention to portfolio construction and weighting techniques,” Stobie explains. “At the end of December, the biggest single share weighting in the portfolio was only 4.6%. It also gives you effective exposure to 41 shares.”
In addition, it delivers lower volatility.
“It is where the market has gone globally,” Stobie says. “Four or five years ago the early adopters were buying single factor indices, but more and more clients are moving to a multi-factor framework. It avoids the timing and cyclicality issues that one tends to experience at a single factor level.”
One might suggest that the recent poor performance of the Equally Weighted Top 40 Index has made products that track it less appealing. As the below table shows, it has underperformed the Top 40 significantly over the last six years.
Before that, however, it did show marginal outperformance. This is generally what one would expect from this index given that it minimises concentration risk and gives investors effective exposure to more companies.
In addition to the investment case, Stobie says another motivation for CoreShares to change the mandate of the fund away from the Equally Weighted Top 40 is to bring more clarity to its product offering.
“We’ve gone back to the drawing board and asked what are the ETFs (exchange-traded funds) that we think are most useful for investors,” Stobie explains. “What we don’t want to do is fall into the trap of product proliferation in the ETF market.
“As it is, there are well over 20 South African equity ETFs that you can buy on the JSE, and we don’t think that’s particularly helpful, particularly if you have individual smart beta strategies like value, momentum and quality that are quite cyclical through time,” he adds. “What ends up happening is that investor behaviour creeps in where the strategy is bought at the top of the cycle and sold at the bottom of the cycle.”
CoreShares instead believes that it should restrict itself to three areas. The first is a simple, market-cap-weighted product, which is the most simple for investors to understand.
The second is a dividend strategy that gives investors who require an income to generate some of that from the equity market.
The third is smart beta. However, it has chosen to avoid single factor strategies in favour of something it believes is more investor-friendly.
“We wanted to avoid the trap of having a value fund, a momentum fund, a quality fund, and leaving investors with the dilemma of having to choose between them,” Stobie explains. “A multi-factor strategy might seem more complex, but actually we are doing a lot of the heavy lifting for investors by allocating across that spectrum of smart beta opportunities. So the same thing that makes it complicated is also what makes it neat. It simplifies one’s exposure to all of the factors.”
Investors are currently being balloted on the change. If they agree that the fund can change its mandate, it will mean that there will no longer be an equally weighted Top 40 ETF available on the JSE. However, investors who want to invest in a product that tracks this index will still be able to do so through the Satrix Equally Weighted Top 40 unit trust.