Thomas: FlexShares Eyes Dividend Space

Shundrawn Thomas, head of Northern Trust's exchange-trade fund unit FlexShares, has always maintained that Northern Trust's second foray into the ETF business would be very different than its first effort that ended suddenly in 2008 during the financial crisis. So far so good. The firm has gathered almost $3.5 billion in assets in less than a year and a half, and has at least one blockbuster fund, the $1.62 billion FlexShares Morningstar Global Upstream Natural Resources ETF (NYSEArca:GUNR).

FlexShares also finds itself smack in the middle of three of the more important trends in the ETF industry; namely, self-indexing; factor-based investing; and actively managed funds. Thomas, visiting recently with's Managing Editor Olly Ludwig, stressed that the key to the firm's success is simply listening to clients before FlexShares designs new products in an increasingly competitive industry. of the things that continues to astonish me, Shundrawn, is that you guys are getting traction. This is an industry where the easy money is in the rearview mirror. You can't throw spaghetti at the wall anymore, and your firm is raking in the assets. What's your secret?

Thomas: Certainly, some of the easy ground is covered, and one of the things we always think about from a strategy standpoint is to go where growth is. We're of the opinion that there is substantial growth opportunity with some of these newer strategies-we've taken all newly created indices with more of a factor-based approach and really evolved our strategy to focus on specific gaps or needs articulated by investors.

So we spend lots of time talking to investors, and that informs our development strategy. I think it helps when you're involving investors, and then you go back to distribute those products. So there's no magical answer for us. There's no easy button, but that's how we've approached it. just said something important:"factor-based." Do you have a strong opinion about cap-weighted methodologies? After all, you are, as you say, rather factor-based in your approach.

Thomas: People may have deep convictions about, say, market-weighted versus equal-weighted methodologies. Our thinking is more about the best way to achieve a certain investment outcome. Part of the reason you haven't seen us have a significant focus on "market-weighting" is not so much because we think there is something inherently bad about it. It's more so because of two facts. One, we think it's well covered. So to come out and try and cover a space that's already well covered doesn't make sense.

The other thing is, when we've looked specifically at the strategies we're looking to pursue for that particular strategy or those outcomes, we just accept that, as investors, we may not believe it's the best way to achieve it. And we think a lot of times what happens is that people default to things. But we have a very strong empirically based approach. We say we have to go where the facts lead., as far as products that we can look forward to from Northern Trust's FlexShares, what kind of strategies might we look forward to in the coming months, if not years?

Thomas: I can speak to things that people may not have focused on, and it will give you a good sense of where we're moving towards. I would say emblematic of where we're moving towards would be our most recent introduction-a suite of three quality dividend funds.

What's unique about those is in the same way that all of the other FlexShares products are newly created indices done under our self-indexing mandate. We got exemptive relief for that. Why is that important? Because while we believe there will be more opportunities to partner with index providers, we also think we have unique capabilities at Northern Trust.

For instance, we worked with our quantitative management team and the folks on my exchange-traded funds team to come up with a methodology that maximizes the intersection of quality and yield. We have a quality score that's embedded inside of the index methodology. We think that builds our brand and allows us to deliver something that's unique to the marketplace.

The other thing it helps is our speed to market. Believe it or not, it's more efficient that way. While collaboration is great, there are costs to it and trade-offs, one of which is time. noticed that, actually. Those dividend funds went into registration and suddenly, "Wow, already?" I remember being surprised.

Thomas: That's a perfect example of what we would like to do. If I can just add to that, if you look at the components of managing liquidity, and then generating income, that's where we have been focused more recently. We think there's a lot of demand in the marketplace, if you think about the biggest itches where investors are scratching. what are some specific funds that might come out in connection with liquidity and income?

Thomas: From a liquidity standpoint, we have a relatively new fund. In October of last year, we introduced (NYSEArca:RAVI). It's our Ready Access Variable Income fund. We've been in the cash management business for decades, so RAVI is a perfect example of leveraging Northern Trust's expertise. It's also our first active product.'s the one that's kind of like MINT from Pimco, right?

Thomas: That's what we get compared to, yes. But what drove us there is we looked at what we believe were significant market and sector shifts and the way that people are looking at management and managing cash. Look at all the things that are going on with money market mutual funds-people see problems; we just see opportunities. The environment we're going through-persistent low interest rates and all the noise from a regulatory standpoint-we don't think that gets solved next month. And so it would make sense. if you're really serving investors, to think about what kind of alternatives you're providing there. are you saying more of the self-indexing strategies are probably likely?

Thomas: Yes. not exclusively, at the same time.

Thomas: But not exclusively; yes, absolutely. general observations you can share regarding the industry? I said at the outset, for example, you can't throw spaghetti at the wall. Clearly, Northern Trust understands that. Here is an industry where there are a lot of closures, but assets are at record levels. No one is saying this thing is slowing down. But its texture has changed a little bit.

Thomas: I think so. We spent a ton of time looking at flow trends, and one of the things I observed is that 2011 was an interesting year for new product introductions. I remember looking at the end of that year at some research that came out, which said that of the top 18 funds that were introduced in 2011, 18 of them passed $100 million in assets. And only three of those came from the top three providers.

But if you look at that same statistic for 2012, that changed. And about 69 percent of the flows in 2011 went to the largest three providers; that was like 80 percent last year. We saw an emphasis away from risk last year, regardless of what people say. And I think that favors incumbency. I don't say that in a negative way. I just say that as an observation.

I'm really looking very hard to see what happens this year. Because if January is an indicator of what the year is going to be like, I think we saw more of a true risk-on trade-95 percent of the flows went into equities. People were saying people took money off the table in commodities. But really, it was money flowing out of gold ETFs , not commodities broadly.

So if that were to persist, my expectation is that that creates an environment for more innovation, more receptivity to broad, basic strategies. And it will be interesting to see, from an industry standpoint, if that is true. is to say, some of the providers that are smaller than the top three are going to get traction.

Thomas: Right. And again, I think we're still so early in the growth stages of the industry that there is enough room for everybody. That doesn't mean everybody should be successful. Quite frankly, you've got to earn your keep. And so, if you don't have a value proposition that's attractive to the market, I don't care if you're an incumbent who's been around for years or if you're somebody that's come to the market yesterday:You don't earn your right in the marketplace.

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