Continuing with the over 25 years tradition of leading product innovation, we are once again set to launch Pakistan’s first Smart Beta Exchange Traded Fund – JS MOMENTUM FACTOR ETF.

2021 has been a banner year for tech disruptions that are redefining business models across different industries. When we talk about the investing industry, Exchange-Traded Funds (ETFs) have been one of the most disruptive forces in recent years. However, it’s the Smart Beta ETFs that have taken the investing arena by storm in the last two years and have accumulated over $1 trillion of investments globally.

What is Smart Beta?

Smart beta is a rules-based portfolio-building process that systematically selects, weights, and rebalances portfolio holdings based on factors or characteristics versus a market capitalisation approach. Smart Beta & Factor Investing strategies have been developed by academic experts and practitioners to address the limitations of traditional indices. Active equity mutual funds typically allocate money to companies by combining sectors that will perform corresponding to the prevailing economic cycle. Smart Beta and Factor Investing funds diversify differently, these funds tilt exposure towards ‘factors’ that have been proven historically to capture market inefficiencies. In other words, Smart Beta indices incorporate diversified exposures to various sources of equity returns.

Why Smart Beta?

We are indeed charmed by the success and growth of factor investing and feel industry is mature enough to think beyond sector rotation and theme investing. We also strongly believe that our markets offer tremendous opportunities to gain from factor risk premia such as Momentum, Volatility, Small Cap, or Dividend Yield. More importantly, however, when you hear the buzz like active managers have failed to impress investors or see data that shows 60% of active fund managers have underperformed the benchmarks (KSE-100/KMI-30) over the last ten years, you know that there is a lot to be done on this side of the world. Enigmatically, managers that consistently outperform or are true to the label are difficult to find. Over the past 3 years and even 5 years, we’ve observed equity funds that were in the top quartile of their performance, failed to sustain it through the subsequent quarters. Out of 38 equity funds, only 5% of the funds managed to maintain performance in the top quartile for over 1 year and none of the funds were able to maintain it for 2 years. (Yes including ours!)

Making investment decisions in an increasingly data-driven world with ever growing intricacies of size/speed and nature of information is becoming difficult. Smart beta ETFs would pave the way to a durable investment style that displays both active and passive investment management features. It follows a consistent portfolio construction methodology and rebalancing, which we believe improves portfolios’ overall risk-return characteristics that aim to provide exposure to persistent drivers of performance and deliver attractive risk-adjusted returns, enhanced efficiency, and transparency.

Why Momentum?

Factors can include dividend yield, momentum, value, size, and volatility and each will perform differently depending on the market and economic cycles so why did we choose to create an index based on a single factor ‘Momentum’.

Well, momentum is persistent. Further, very often we hear the word Speculative stocks used in our markets that have harmed our financial markets from growing and frightened our small investors from wealth creation. We perhaps underestimate the skill of stock pickers who deal with a rapidly expanding information base, conduct due diligence, and take a calculated risk in a turnaround story or change industry dynamics by being ahead of the rest.

The momentum index combines the skill of all such managers and packages in a portfolio that tracks this skill set. In other words, the index invests in trend stocks through a program-driven decision-making tool and is an alternative for investors who were broadly divided into active and passive investing worlds by modeling fundamental measures of size, dividends, cash flow, and/or variance.

Although the evidence for momentum is supported by almost two decades of academic research in US equities as well as markets outside the U.S, our backtests reveal that momentum has also outperformed our local stock index i.e. KSE-All-share index by 6% annualized over 2001 – 2021. Over this period the KSE All Share has returned 19% p.a. Momentum has delivered attractive Sharpe ratios (risk-adjusted returns) as well, the backtest reveals the strategy has a Sharpe ratio of 1.59 vs. 1.25 for the KSE All Share index.

However, I would urge you to keep in mind that evaluating the success or failure of the strategy on how the ETF trades in the first few weeks is not an indicator of future performance. Like any stock traded on a public market, you cannot evaluate the strategy performance over the short term. If you want to gauge the success of ETF over the long term, then it’s better to look at the performance of a minimum of 3 years else you can trade in short cycles.

We would like to celebrate the ETF launch as a monumental milestone. We believe it will pique investor interest – be it the first-time investor or a seasoned investor in PSX. This fund is not the end of the road but the way to take the ETF journey towards the next stage of growth in Pakistan, and help investors understand the value of combining passive and active investing styles. JS-Momentum Factor ETF is just the beginning!

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Disclaimer: All investments in Exchange Traded Fund are subject to market risks. The investors are advised in their own interest to carefully read the contents of offering document in particular the investment policies mentioned in clause 2.2. Risk Factors mentioned in clause 2.7 and warnings in clause 10 before making any investment decision.

The article does not necessarily reflect the opinion of Business Recorder or its owners