Legg Mason (ticker: LM) decided it’s better late than never. The Baltimore investment management company is one of the most experienced in the world. It has roots dating back to 1899, and its first mutual fund — Legg Mason Value Trust (LMVTX) — came to life back in 1982.
But when it comes to exchange-traded funds, Legg Mason is a spring chicken.
After a couple of misfires — including filing in 2011 for a fixed-income ETF that never launched and filing in 2012 to create some index products — Legg Mason finally hit the launch pad this year, releasing a four-fund line of ETFs in January. The offerings:
— Legg Mason US Diversified Core ETF (UDBI)
— Legg Mason Developed ex-US Diversified Core ETF (DDBI)
— Legg Mason Emerging Markets Diversified Core ETF (EDBI)
— Legg Mason Low Volatility High Dividend ETF (LVHD)
Legg Mason is used to being an entrenched player and has amassed $657 billion in assets under management, making it 21st in the world in that category . The question now is: Can Legg hang as an upstart?
The first three of Legg Mason’s four ETFs acts as something of a mini-portfolio that covers the spectrum of investment geography. UDBI, DDBI and EDBI cover the U.S., developed markets and emerging markets, respectively.
These smart-beta ETFs are all governed by a proprietary diversification-based investing methodology from Legg Mason affiliate QS Investors that the company hopes can offer a more competitive blend of holdings than its traditional indexed rivals. Rather than leaning on simple weighting of market capitalization, the methodology aims to provide a more balanced set of holdings and a better risk profile.
“If you look at country or sector exposure as a percentage of risk, it tends to be about 40 to 60 percent of total equity market risk,” says Mike LaBella, a portfolio manager with QS Investors. “Think of things like cyclical sectors versus countercyclical sectors, or things like safe haven countries versus oil-exporting countries. These have very different behaviors, and we want to make sure our investors are well-balanced across these macro risks.”
In the case of DDBI and EDBI, much of the effect you get from the methodology is taking out the outsize sector weightings that many international funds give to certain countries. For instance, Japan and the U.K. together make up more than 40 percent of the iShares MSCI EAFE ETF (EFA), but that drops to a combined 24 percent in the DDBI. That could be beneficial, considering that Japan currently is a bet on whether Abenomics will work, while the U.K. will vote in June about whether to exit the European Union.
UDBI obviously isn’t concerned about country risk. Instead, “because the U.S. is such a deeper market, we find it beneficial to go below sector and look at underlying industries,” LaBella says.
Legg Mason US Diversified Core ETF (UDBI). A consumer-stock-heavy fund, with more than 35 percent of the fund split between staples and discretionary. Health care, industrials and utilities also receive double-digit weightings. No individual holding among its nearly 1,500 stocks makes up more than 2.29 percent of the sector’s weight, with stable companies like AT&T (T), Philip Morris (PM) and Procter & Gamble (PG) anchoring the fund up top. Charges are 0.3 percent, or $30 per $10,000 invested annually.
Legg Mason Developed ex-US Diversified Core ETF (DDBI). A collection of 566 holdings across more than 20 countries, with highest weights going to Japan, Canada and Australia. Sector spread is excellent, with six sectors weighted in low double digits, and the lightest-weighted sector (energy) still comprising 6 percent of the fund. Charges 0.4 percent.
Legg Mason Emerging Markets Diversified Core ETF (EDBI): Like most emerging-markets funds, EDBI has China as its top country weighting, but it’s far less outsized than most funds at just 12.79 percent in weight. That’s closely followed by Malaysia (10.59 percent), with India (9.8 percent) and Turkey (7.33 percent) getting significant weight in the fund, too. Also typically, financials are the largest sector weight, but that’s more balanced than most emerging-market ETFs, too, at just 14.59 percent of the fund. Charges 0.5 percent.
That brings us to the final fund, which is something of an outlier.
Legg Mason Low Volatility High Dividend ETF (LVHD). This ETF is an attempt at getting the best of a couple of worlds: low volatility and high dividends — as the name would suggest. Many investors assume a certain level of quality along with dividend stocks, as the ability to pay a substantial, regular stream of cash is a sign of financial stability. But, as many dip-buying investors in the oil patch over the past year would tell you, at a certain point, a high dividend yield can actually be a sign of trouble — because that yield might be the result of a rapidly declining share price amid a growing inability to keep paying that dividend.
Thus, LVHD applies a number of screens to find a happy middle ground: “We screen the universe for high-dividend payers, but we also have a quality screen. It has to have a sustainable dividend. It needs to have a profitability ratio that means it can support the dividend it’s paying out,” LaBella says. “We look at trailing and forward profitability, payout ratio has to be less than 100 percent. Now we want to bring in the low-volatility component. We look at the company’s earnings volatility and price volatility.”
The result is a pretty balanced fund of stable, fairly high-paying dividend stocks — such as Verizon Communications (VZ), Eaton Corp. (ETN) and Cummins (CMI) — that each currently make up no more than 2.76 percent of the fund’s weight.
The only available yield for LVHD currently is its 30-day SEC yield, which comes to 4 percent — but at least on that basis, that makes LVHD a higher-paying option than many of the more traditional dividend ETF names out there. However, high-yield hunters still have more top-heavy options in the way of funds like Global X SuperDividend U.S. ETF (DIV), 7.6 percent) or the PowerShares KBW High Dividend Yield Financial Portfolio (KBWD, 12.7 percent).
The LVHD doesn’t have much in the way of historical returns to study, but for the year, the index that Legg Mason’s ETF is built upon has beaten the Vanguard Dividend Appreciation ETF (VIG) 6 percent to 1.5 percent amid a down broader market.
Should you invest? Legg Mason appears to have put together a thoughtful quartet of funds, with its core funds providing a new look at core U.S. and international holdings, and its LVHD at least capable of weathering lousy market environments.
But Charles Sizemore, a portfolio manager on Covestor and chief investment officer at Sizemore Capital Management, a registered investment advisor in Dallas, points out a danger that Legg Mason faces regardless of the quality of its funds.
“There is definitely a first-mover advantage when it comes to ETFs due to volume issues,” he says. “The more trading volume you have in an ETF, the easier and faster it is to quickly trade in and out of the position. And the advantage here clearly goes to the established ETFs that have been trading for years.”
Indeed, through a couple months of trading, EDBI boasts just $6.4 million in assets. ($10 million is a commonly touted low-water mark for ETF assets.)
So now, the mission is simple, though daunting: Stand out in the noise of a cluttered ETF landscape, and overcome investor inertia.
“In order to get any traction at this point, you have to offer something fundamentally different — which is exceptionally hard to do at this point, as most smart-beta strategies have long since already been claimed — or spend a fortune on marketing and hope for the best,” Sizemore says.
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Legg Mason: a Thoughtful Quartet of New ETFs originally appeared on usnews.com
