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Client-centric BBH offers thought leadership on smart beta direction


Donavan Brown, assistant vice president with Brown Brothers Harriman (BBH), explains that there are three parts to its business: Investor Services which caters to asset managers and financial institutions; the Private Banking which offers Corporate Advisory and Banking, Private Equity and Private Wealth Management, and an Investment Management business with a variety of equity and fixed income strategies.

The ETF business lies within the Investor Services part of the bank, and while BBH has no proprietary exchange traded products, it has over USD500 billion of assets under custody on behalf of its clients.

Since starting its ETF business in 2004, BBH has launched with over 30 ETF sponsors, offering a number of services like custody, fund accounting, and ETF specific services such as PCF creation and order taking. BBH also offers Authorized Participants (APs) a platform called APEX which allows them to place orders electronically instead of phoning them in. “Our goal is to be viewed to as an extension of our client’s business,” Brown says. “When they decide to launch ETFs, we seek to understand the operational nuances associated with their investment strategy. What differentiates our offering, though, is the deep experience of our product teams paired with the breadth of strategies deployed by the ETF issuers on our client roster.”

Brown explains that clients come to BBH because of the firm’s subject matter expertise and connections within the industry. “We understand what it takes to launch an ETF and continue to work with our clients post-launch. Whether it’s introductions to different parts of the ETF ecosystem, or helping decipher regulatory requirements, there are a number of different reasons our ETF business has grown. We also provide thought leadership to our clients informing them, as we leverage our contacts, of regulatory changes or trends from ETF issuers and advisors. Our Exchange Thoughts series is one of the ways to deliver those unique insights to our business partners, both current and prospective.”

Brown believes that smart beta has far-reaching potential. “Smart beta is one of the most fascinating developments in the ETF story, attracting as many assets as opinions,” Brown says.

Brown describes smart beta as a hybrid of active and passive investing, and as active due diligence combined with passive implementation. “Implementation is done using a rules-based methodology, which is intended to diminish irrational behavior during periods of market volatility or prolonged underperformance.”

Brown feels that a combination of factors have supported growth in the smart beta sector. The active versus passive debate continues and there will always be proponents for both sides. Smart beta is relevant to both parties and can help address some of the shortfalls associated with each side whether you believe in active, passive or are simply looking for a new way forward.”

This is an interesting point for Brown as smart beta ETFs often come with a premium as compared to vanilla ETFs, but may still be seen as cost effective relative to actively managed products.

“Smart beta ETPS, on average, have lower fees than actively managed funds but are still more expensive to own than index based products. For example, according to Morningstar, the average TER of smart beta ETFs using the S&P 500 as its index is three times higher than a plain-vanilla S&P 500 ETF. Higher trading costs, higher index licensing fees and other costs such as research and marketing also contribute to the premium for smart beta.”

Brown believes the next growth sector for smart beta lies within fixed income. “So far, most of the smart beta assets are equity ETPs but as we see greater adoption of smart beta across the board, there will be more opportunities for growth in fixed income.”

Brown comments on the challenges: “The risk profiles of smart beta equity and fixed income products are different: in equity markets, risk is stock-specific; in fixed income, the main concerns are interest rate and credit risk.  There are also impediments such as high trading costs and concerns around liquidity for fixed income strategies. Another challenge for fixed income is the lack of long term data on bonds. That puts into question the accuracy of back-tested models. Despite these headwinds, opportunities still exist for fixed income. There appears to be interest in an alternative weighting methodology, away from the standard index construction based on the market value of debt, so keep an eye on this asset class as the smart beta story continues to unfold.”

In conclusion, Brown feels there will be continued demand globally for smart beta. “According to BBH’s annual ETF investor survey, 97 per cent of US financial advisors and institutional investors stated they planned to maintain or add to their smart beta positions in 20171. We’ve seen year-over-year growth for the number of smart beta products launched and increased usage not only in the US, but also Europe and Asia. As the product develops and overall adoption increases across ETF issuers, advisors and investors, don’t be surprised if we witness smart beta allocation move from marginal exposure to becoming a core part of the overall portfolio”.

The views expressed in this material are those of the author as oft 24 November 2017 and may or may not be consistent with the views of Brown Brothers Harriman & Co and its subsidiaries and affiliates (“BBH”), and are intended for informational purposes only. Information contained herein is based upon various sources believed to be reliable and subject to change without notice. Furthermore, these positions are not intended to predict or guarantee the future performance of any currencies or markets. This material should not be construed as research or as investment, legal or tax advice, nor should it be considered information sufficient upon which to base an investment decision.

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