New ETF player

Although First Trust is new to the Canadian ETF market, it has been operating in Canada since 1996, developing and managing white-label products for other financial services institutions, as well as closed-end funds and a mutual fund under the First Trust label. Its Chicago-based parent company (First Trust Portfolios LP, a global investment firm) was established in 1991 and has about US$85 billion in assets under management (AUM) or supervision, including ETFs, variable annuity funds, closed-end funds, separately managed accounts and unit investment trusts (which are similar to closed-end funds but with a predetermined maturity date).

“In the past,” says Fraser Howell, president and chief financial officer of the Canadian subsidiary, “we didn’t have a ton of brand recognition in Canada, as many of our successful products were marketed under another financial services institution’s name. But, a few years ago, we made a decision that was not where we wanted to go.”

In part, the decision to focus on ETFs in Canada was taken following the parent company’s success in the U.S., Howell says, which has mushroomed to US$20 billion in AUM in 82 ETFs since the products were first introduced in 2007.

“We looked at our growth and success in the U.S. and decided to change tack in Canada,” he continues. “The mutual fund business is mature, highly competitive and becoming more so. We decided to look at the ETF space and offer a different product.”

In the past year, First Trust has introduced three ETFs in Canada that are hedged to the Canadian dollar (C$): First Trust AlphaDEX U.S. Dividend Plus ETF, First Trust AlphaDEX Emerging Market Dividend ETF and the actively managed First Trust Senior Loan ETF; as well as First Trust AlphaDEX Canadian Dividend Plus ETF, which is not hedged.

On Feb. 4, the firm announced the introduction of First Trust AlphaDEX European Dividend ETF (C$-hedged), which Howell calls “the first European equity ETF to be listed on the [Toronto Stock Exchange].”

AUM in these ETFs stands at about $50 million combined.

Howell describes the firm’s quantitative investment-management approach as “enhanced indexing.” In First Trust’s proprietary “AlphaDEX” process, the firm screens the universe of companies in a broad market index based on criteria such as price/book ratio, price/cash flow ratio and sales growth, then selects 40 to 60 of the most attractive stocks. Portfolios are monitored and rebalanced on a quarterly or semi-annual basis; weightings of holdings are adjusted as their ratios fluctuate.

The securities in the AlphaDEX portfolios are not weighted by market capitalization as they are in the broad indices; instead, they are weighted according to how they rank in the growth and value screens that First Trust employs.

For the five years ended Dec. 31, 2013, 15 of the original 16 AlphaDEX ETFs introduced in the U.S. in 2007 beat their performance benchmarks by an average of 3.9%. Says Howell: “We stick to a rigorous, relentless, disciplined quantitative approach.”

Dan Hallett, vice president and principal with Oakville, Ont.-based HighView Financial Group and a fund analyst, says that although First Trust has been in the Canadian market for some time, it needs to offer a product that both adds value and is not already available in order to compete in the ETF space with large competitors such as BlackRock Asset Management Canada Ltd., Vanguard Investments Canada Inc. and Bank of Montreal (all based in Toronto). Says Hallett: “It’s a tough market segment to break into, and it will be a battle against the dominant players. First Trust will need to prove that the strategy it’s using is somehow better than what’s out there, as it’s not competing on price.”

Although rules-based ETFs provide the advantages of low management costs, liquidity and tax efficiency, Howell says, his firm saw an opportunity to add value through true active management, including bottom-up fundamental credit analysis with First Trust Senior Loan ETF. (Credit analysis involves an evaluation of the economy and industry trends, as well as the issuer’s cash-flow consistency, collateral coverage and management quality.) This ETF has a management fee of 80 basis points (bps), which is higher than the 60-bps management fees for First Trust’s U.S., Canadian and European equity ETFs and the 65-bps management fee for the emerging markets ETF.

Aside from a product lineup that’s “not me too,” Howell says, the other prong of the firm’s strategy is building distribution. First Trust hired Bobby Eng, previously director and head of national accounts with BlackRock’s iShares division, as senior vice president and head of sales. On the product-development side, First Trust hired Karl Cheong, formerly head of product for Claymore Investments Inc. (acquired by BlackRock in 2012) as senior vice president.

“We are embarking on a slow, steady process of building assets,” Howell says. “We have ambitious but achievable targets.”

Howell points out that there will be “continuous and frequent” new product offerings, including funds with geographical and sectoral focus. All First Trust ETFs are available in a common-class version and an advisor-class version that pays a trailer fee.

The firm’s equity funds will offer the same AlphaDEX process, reflecting First Trust’s view that the market is not efficient and that a more profitable strategy is to screen stocks for desired characteristics rather than to own every stock in the universe.

Howell doesn’t expect this strategy to outperform in all market conditions or time periods, but he expects that it will over the long term. On average, he says, First Trust’s ETFs in the U.S. have captured more of the market upside in rising markets than they have captured the downside in bear market.

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