Two Novel Smart Beta Factors That Could Enhance International ETF Exposure

The smart beta exchange traded fund universe is quickly expanding as money managers employ various market factors and come up with new ways to potentially enhance returns or diminish risk exposure.

Among the new innovations that could hit the space, the so-called Tranching and Fama-Macbeth OLS Regression Methodology, are two novel features that could change the way international ETFs provide country exposure.

Outlining a potential construction of a multi-factor fund-of-funds diversified international portfolio through single-country ETF components, Sailesh S. Radha, president and chief investment officer at Borealis Global Advisory, wrote a paper found in the summer edition of the Journal of Index Investing, titled “Global Country Allocation Framework: A New Paradigm for Constructing an International Fund-of-Funds ETF,” that two new novel components that go beyond traditional features of smart beta investing include tranching and the Fama-Macbeth (FMB) ordinary least squares (OLS) regression methodology.

Tranching is described as a novel scheme that classifies investable entities of a given type found in a benchmark or index universe into groups by high level investment attributes like market-cap, volatility, degrees of correlation, style and levels of development.

By breaking down the benchmarks into groups of chosen types of investment entities, Borealis Global Advisory are separating them into so-called silos that exhibit certain attributes to more clearly derive factors that drive the returns of the entities in each tranche.