Smart Beta Product Highlight

We enjoy highlighting new and innovative ETF strategies as exchange-traded-products have exponentially expanded the universe of available investment options in a transparent, cost effective and tax-advantaged manner.  With strong outperformance by international equities so far in 2015, we sought a fund to highlight offering diversification and a strategy easy to understand.

Our search brought us to the Vident International Equity Fund (VIDI) where a unique rules-based approach creates a fund offering international exposure beyond most market cap weighted products.  Unlike the MSCI ACWI ex US Index, where the market cap weighting results in an 85% allocation to developed markets, the Vident International Equity Index focuses on identifying countries that have policies to promote human capital and deliver superior long-term returns.

Consisting of 35 different countries, the index is equally weighted before the first reweighting based on stress testing to determine how sensitive each market is to a variety of economic shocks.  Further adjustments are made based on 4 broad headlines:  growth (tax and regulatory burden), sound money (trade barriers, financial regulation), political stability (rule of law, corruption) and price (current market valuations to fundamentals.)  A final screen looks at momentum and other corporate fundamentals to quintile the countries with automatic adjustments to the overall market allocation reconstituted every January and rebalanced in July.

Given the weighting system, it’s not surprising that its performance has a strong emerging market flavor compared to the iShares MSCI ACWI ex US (ACWX) fund.  Since VIDI’s inception on 10/30/2013, the fund has returned -1.35% compared to 1.05% for ACWX and -2.33% for the iShares MSCI Emerging Markets Index ETF (EEM) and is currently underperforming ACWX in 2015 by 1.2% (up 4.1% to ACWX’s 5.37%.)   The main culprit is a greater weighting towards Asia where the fund has nearly twice the exposure to emerging market positions than ACWX in countries like Malaysia and India with the fund’s largest single position is a 2.4% allocation to the iPath MSCI India ETN (INP), up 8.56% YTD.  The larger Asian allocations come at the expense of developed European markets where the largest underweight is the United Kingdom with the fund maintaining a small 2% allocation (compared to ACWX’s 14.5) due to what they feel are weaker growth prospects and already high prices.

Despite the above, VIDI has managed to grow to over $740 million by offering investors more than just one-stop shopping for the international sleeve of their portfolio.  VIDI offers a transparent and understandable portfolio management solution that is also cost effective.  While not considered to be an actively managed fund by ETFG, the .75% expense ratio charged by the fund for the annual reconstitution and rebalancing may be more palpable when compared to the fee’s charged by active mutual fund managers in the foreign large blend or emerging market categories where the average fee’s in 2014 were 1.23% and 1.58% respectively.  Those higher fee’s haven’t greater performance in 2015 with the average EM fund up 2.3% and the average FLB fund is up 5.49% excluding any front-end charges.

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