Westwood Holdings Group has introduced a new exchange-traded fund that will allow investors to match their political beliefs, by avoiding investments in countries that have authoritarian regimes.
The new equity exchange-traded fund, called Westwood LBRTY Global Equity ETF, was launched on March 27 and trades under the ticker BFRE. It invests in countries with strong institutions, civil liberties and rule of law.
BFRE will seek to have limited exposure to “companies that are likely subjected to the economically irrational, unpredictable and corrupt behavior of autocratic governments,” according to an SEC filing.
Drew Miyawaki and Shaun Murphy, both of whom are part of Westwood’s managed investment solutions team, are the portfolio managers on BFRE, said Greg Behar, head of MIS at Westwood.
The ETF is available to both retail and institutional investors, a spokesperson for Westwood confirmed. Dallas-based Westwood had $17.6 billion in assets under management as of Dec. 31.
TOBAM, a Paris-based quantitative asset management firm, is the index provider for the LBRTY All World Equity index, the benchmark that BFRE will track.
Behar described the new ETF as an index product, but one with an “actively designed rules-based index methodology.” It carries an annual expense ratio of 0.50%.
The LBRTY All World Equity index is overwhelmingly dominated by democracies, with the U.S. accounting for a 76.9% allocation, followed by Canada (6.1%), U.K. (4.1%), France (4.1%) and Japan (2.1%).
“BFRE’s top country weights will look familiar as many of the largest economies in the world are democracies,” Behar said.
“The notable differences to the top 10 country weightings (as) compared to (other) market cap indexes are a removal of China and an underweighting of India. Where BFRE’s design differs is the exclusion of the autocratic countries while penalizing the weights of stocks from free markets with high exposure to authoritarian regimes.”
TOBAM “came up with this unique methodology, backed by years of research, to identify and manage the risk to public equity portfolios posed by authoritarian regimes whose decisions are not driven by the best interests of the economy and investors," he said.
The managed investment solutons team at Westwood chose to license the LBRTY methodology for its “effective approach to mitigating authoritarian risk,” Behar said,
“After numerous conversations with clients and prospects we identified a common theme; investors are worried about geopolitical risk and its effect on specific country and regional holdings but also across their portfolios,” Behar stated.
There is growing recognition that autocratic countries such as China, “that lack solid institutions and rule of law, present an unrewarded risk for long-term investors.”
As such, the strategy does not invest at all in companies listed in autocratic countries such as China, Russia, and Turkey, among others, Behar noted. “It also reduces exposure to companies that are listed in democratic countries but are, in fact, heavily reliant on those autocratic markets that were removed from the index,” he added.
To define “authoritarian,” BFRE uses a proprietary quantitative methodology that draws on the publicly available datasets of institutions that measure democracy around the world, such as the V-Dem Institute and Freedom House. “They are experts in democracy and have been closely tracking the fortunes of democracy globally for decades,” Behar said.
Behar said he believes this is a first of its kind ETF.
“Other ETFs in the space focus just on international or emerging markets and are not looking at the global indirect risk of authoritarian regimes,” he said. “BFRE is the only ETF available that is based on the LBRTY methodology. This design addresses portfolio risk at multiple levels: direct country risk, indirect country exposure, and beta, sector and tracking error misweights to the broader global benchmark.”
Other ETFs that use country exclusion, Behar said, only focus on removing direct investment in a market and do not account for the substantial indirect risk that the portfolio still has to the removed countries.
Bryan Armour, director of passive strategies research for North America at Morningstar, said this new ETF from Westwood differs from existing strategies by including developed markets countries, which shouldn’t be as affected by the authoritarian regime exclusion, and focusing on companies with minimal reliance on authoritarian regimes.
“A global portfolio should already reduce the risk of government intervention in countries like Russia and China, so those exclusions won’t have a major impact on the portfolio,” Armour said. “Considering a company’s exposure to countries with authoritarian regimes could add a new layer of risk management with the potential to have a bigger impact on the portfolio. Investors should keep a close eye on how aggressively the ETF excludes companies that generate significant revenue in China, for example.”
BFRE is the third ETF on Westwood’s platform, following the $85 million Westwood Salient Enhanced Midstream Income ETF, which trades under the ticker MDST, and the $17 million Westwood Salient Enhanced Energy Income ETF, which trades under WEEI.
Both MDST and WEEI are actively managed energy ETFs with an options overlay designed to maximize income, Behar noted. These energy-themed ETFs were launched in spring 2024.
While the LBRTY All World Equity index completely excludes China and Russia, it does have a tiny 0.17% weighting in the huge and rising economy of India, nominally a democracy, but wracked by widespread corruption in government and corporations.
Transparency International, the German-based global organization fighting against corruption, gave India a corruption score of 38 last year; a score of 100 is “very clean” and zero is “highly corrupt.”
“Within the LBRTY methodology, India is currently included in the investment universe even though it's close to the cutoff line and subject to regular assessment,” Behar said. “The methodology considers corruption within a country and is fluid and dynamic and adjusts as countries shift over time between autocracy and democracy. The institutions that measure democracy around the world issue annual reports and document trends. Depending on the evolution of their ratings, countries can be included or excluded from the LBRTY investment universe.”
Similar ETFs
A similar ETF is the Democracy International Fund ETF, which trades under the ticker DMCY and has about $9 million in assets. This ETF tracks the Democracy Investments International index, which weights investments based on The Economist magazine Democracy index and gives higher weightings to democratic countries and lower weightings to authoritarian countries.
Julie Cane, CEO and managing partner of Democracy Investments, which runs DMCY, told Bloomberg last October: “We are overweighted in countries that care about free and fair elections, care about security for voters and election workers and care about a peaceful transition of power.”
Cane added that “we don't screen any country out because what if they improve? When do you let them back in? So we have a very systematic tilting process that counts for geopolitical risk and the shifting supply chains that we're seeing.”
Perth Tolle founded Life + Liberty Indexes, which operates an emerging markets ETF, the Freedom 100 Emerging Markets ETF, which trades under the ticker FRDM and now has $914 million in assets.
“We've seen several variations on the FRDM strategy since launching the ETF six years ago, and hope to see many more,” she said. “We are proud to have started this conversation and to see FRDM continue to lead the category." FRDM seeks to invest in emerging markets countries with “higher personal and economic freedom scores” and tracks an index based on personal and economic freedoms based on data from Fraser Institute and Cato Institute.
Behar conceded that many ETFs and mutual funds already prohibit investments in authoritarian countries like China and Iran. But he believes BFRE takes a more hardline approach.
“In today’s interconnected world economy, removing a country does not fully eliminate its investment risk from a fund or ETF,” he said. “China’s economic reach for example extends well beyond its own boundaries. Companies that are neither located nor incorporated in China may still be intricately connected with its economy through supply chains, revenue streams or strategic partnerships.”
As such, these companies would likely be excluded from the ETF or have their weighting reduced to lower the portfolio’s exposure to the removed nations.
Behar said the ETF does have exposure to giant U.S. multinational companies such as Apple that have factories in mainland China.
“The methodology seeks to reduce indirect authoritarian exposure while minimizing tracking error to a global market cap-weighted index,” he explained. “The methodology also aligns companies at the sector level. When comparing similar companies with similar exposures to authoritarian regimes, the methodology will penalize the companies that are contributing less to the tracking error budget. Apple does have exposure to China but there are other technology companies that have similar or greater exposure with less of an effect on tracking error.”
The 2022 invasion of Ukraine by Russia, which led to losses of tens of billions of dollars for Western investors, was a recent reminder of the global interconnectivity within a portfolio.
“With China becoming even more closed and geopolitically assertive, investors should be worried,” he added.
Some U.S. state lawmakers have demanded that their public funds liquidate their investments in specific countries such as China.
“In the last year or so, emerging markets ex-China (products) have become more popular, but they almost systematically fail to address the indirect exposure to China, through stocks listed in other countries but whose supply chains or consumer base trace back to China. This is a major risk that is addressed by the LBRTY approach," Behar said.
Westwood has also submitted SEC filings for two similar ETFs: the Westwood LBRTY International Equity ETF and the Westwood LBRTY Emerging Markets Equity ETF, with the potential to launch one or both in the near future, guided by investor interest.