A pioneer in the booming ETF industry breaks down her approach to the world's hottest investment product (2024)

• Smart beta is a rapidly growingarea of the ETF market, as it allows providers to givean analytical slant to traditional fund indexing.
• OppenheimerFunds offers a suite of ETFs that use a proprietary revenue-weighting methodology.
• One of the firm's funds was recently named Smart Beta ETF of the Year by a trade publication.
• We spoke to Sharon French, the firm's head of beta solutions,about smart beta andthe most pressing issues facing markets today.
• She doesn't buy arguments that the rise of ETFs has suppressed stock market volatility.

It's tough to stand out in the increasingly crowded exchange-traded fund industry.

New funds are launched every day as exchanges clamor to be the place where they're listed, all while investors flock in droves to the most appealing offerings.

Once designed to simply track indexes, the focus of ETFs has broadened considerably. There are funds that replicate specific investment strategies or styles, while some use advanced technology in order to assess stocks for possible inclusion.

Meanwhile, others seek to combine the passive approach of mirroring an index with a more active stockpicking approach — a strategy known as "smart beta." This particular area of ETFs is booming, as it allows providers to flex their analytical muscles, then overlay it onto a universe of companies. In an industry inundated with countless ideas, it's a way to offer something new, andinvestors have responded with great interest.

That's where OppenheimerFunds comes in. The fund provider has introduced a novel approach to the ETF world, by first selecting the components of a specific index, and then weighting them not by market cap — the most common method — but by revenue. The firm's suite of 10 sales-weighted ETFs have a combined market value of more than $2 billion.

In fact, the roughly $500 million Oppenheimer Ultra Dividend Revenue ETF (ticker: RDIV) was given the Smart Beta ETF of the Year award earlier in 2017 by Fund Action, an online publication that covers the space. The fund includes the S&P 900 index securities with the highest trailing 12-month dividend yield, and then weights them by sales.

Sharon French, the head of beta solutions at OppenheimerFunds and a pioneer of the revenue-weighted approach, spoke with Business Insider about her firm's efforts on the revenue-weighting front, and shared some details around the genesis of their award-winning fund. She also shared some thoughts on overall market conditions, and addresses one of the biggest criticisms of ETFs.

Here's what she had to say:

This interview has been edited for clarity and length.

Joe Ciolli:OppenheimerFunds has been a pioneer of the “revenue weighting” ETF strategy. Can you discuss how that came about, and why it's a good approach?

Sharon French:We’re the first and only firm to take this approach. It started back in 2008, and the first product was RWL (Oppenheimer Large Cap Revenue ETF), which revenue weighted the S&P 500. If you’re buying the S&P, you’re buying an index that, because of the market-weighted nature of it, has a propensity to get overly concentrated into a single stock or sector. That brings a lot of unintended risk to the strategy. This really is a much better long-term strategy that offers diversified exposure to the market, isn’t as influenced by stock price and is a truer reading of a company’s value.

This really is a much better long-term strategy that offers diversified exposure to the market, isn’t as influenced by stock price and is a truer reading of a company’s value.

When you backtest it, you find that it’s outperformed.

It’s an alternative weighting technique that really lowers the price-to-sales of your overall portfolio, which is very beneficial. Historically, low price-to-sales relative to market cap has been a better indicator of longer-term returns than other valuation measures.

Ciolli:What does the future hold for this revenue-weighting innovation?

French:We have a suite of 10 revenue-weighted funds, including those with large, mid, and small-cap focuses. We also have international, EM and global funds, as well as two with an ESG focus. And we have more revenue-weighted offerings scheduled for 2018.

Ciolli: Stepping back from your specific products and looking at the big picture — the bull market is looking unstoppable as it goes into its ninth year — how does that shape your approach to things in the ETF business?

French:Our view, based on certain key indicators that we follow very closely over time, is that this is an elongated US credit and business cycle that we believe will persist through the second half of 2017 and into 2018, with the caveat that risks are rising.

Most of the risks are centralized in the US and really not in other major economies. The focus in the US is really centered on the Fed.

The focus in the US is really centered on the Fed.

The US unemployment rate is low, wages are climbing and the dollar is weakening, so our question is: when will the Fed raise rates, and what kind of impact will that have? That’s really where we’re focused.

The Fed intends to reduce the size of its balance sheet, though it will likely be able to successfully navigate that process without issue. But the tightening monetary policy and the flattening yield curve must be considered in combination with elements like modest growth, heightened equity valuations and tighter credit spreads. They’re typically not consistent with some of the outsized valuations and returns we’re seeing in the market. Once that trigger event starts to happen, that’s when we’ll start to get more concerned.

We think international markets are likely to outperform the US, and many international economies are in a better part of the economic cycle. Equity valuations are generally more attractive there, and policies are more certain.

Ciolli:What do you make of the low-volatility environment? And how does it affect the approach of ETF providers such as yourself?

French:There are different factors — low volatility included — that perform better during different types of cycles. Specifically looking at low volatility, it typically does better during a slowdown or contraction. We really haven’t been in one. We believe that’s somewhere out in the future, but not any time in the very near term. During times like this, we’ve found that growth and momentum strategies have done better. We take the different stages of cycles into account when developing ETF products, and help clients arrange their portfolios accordingly.

Ciolli: What’s your approach to that sort of portfolio construction? Do you recommend people hold a blend of multiple factors?

French:We’re introducing single factors, simply because our clients vary in terms of their approaches. They like to use the building blocks to construct a portfolio, depending on the type of market we’re in. For example: Size and value tend to outperform during bull markets, while dividend and low-volatility do better during bear markets.

Size and value tend to outperform during bull markets, while dividend and low-volatility do better during bear markets.

Once you take a longer-term approach, you can either buy a multi-factor strategy off the shelf, or you can take what’s available today with single factors. We do strongly advise that, instead of picking one or two to time the market, that you construct them according to the market environment, and potentially a shift that’s either happened or is forthcoming.

Ciolli: As a smart beta provider, how do you respond to the active managers who have blamed low market volatility on the rise of ETFs?

French:To a large extent, I disagree that low volatility is being created by ETFs.

To a large extent, I disagree that low volatility is being created by ETFs.

There is no single resounding explanation to the lower levels of volatility we’ve seen recently. You will still see spikes in volatility due to market-related or economic events.

When you think about smart beta, it really combines a lot of the attractive benefits of the three main areas of investing: active, passive and alternatives. What I’m finding is that active managers are starting to appreciate that. I feel like it’s a tool for better risk management of the portfolio, and better risk-adjusted return at the end of the day.

Ciolli:What about your ESG offerings? How would you describe your approach there?

French: We consider incorporating elements of environmental, social and governance within our investment analysis as a fiduciary responsibility of ours, and it’s a key focus of our firm. It really starts with our fundamental active strategies, and then applying these elements to the process where it makes sense.

We did introduce, in different wrappers, two ESG funds, and purposely made them broad-based, utilizing both the domestic and global markets. We were getting a lot of client demand looking for ESG opportunities in both areas.

Overall, we have a very full research pipeline that we’re working through and sequencing which products we’ll offer next.