Any exposure that can enhance returns, mitigate risk or both, could find a place in the asset mix. But it must have a beta.
Like every other RIA, we find ourselves on numerous RIA databases and as a result, on the receiving end of countless investment product solicitations. We market to RIAs as well and find the inbound solicitations instructive even if the product or strategy is unappealing, which the vast majority are.
The solicitations are essentially for product in one of two silos: portfolio management strategies in one of several wrappers—primarily ETFs, and asset mix strategies almost exclusively in Managed ETF packaging.
The ascendancy of ETFs has been a windfall for RIAs and other financial advisors who run an asset allocation oriented service offering. They have expanded the universe of potential return sets exponentially. When I first left the market-making / floor trading business and entered the world of investment advice in 1991, a balanced portfolio of maybe 40 large cap stocks and a laddered bond portfolio was cutting edge. Those days are thankfully gone with the ETF wind. That same ETF wind has been blowing pretty hard on all forms of active management. The diversity and the risk-reduction benefits of blending global returnsets is paramount, especially when an advisor is hired to oversee most or all of a clients’ assets. That same ETF wind has been blowing pretty hard on all forms of active management.
This does not mean that any exposure or any blend of exposures or trading schemes wrapped as a strategy make sense. In fact, as the scramble for assets intensifies and RIA service models, the range of product solicitations we receive grows and the strategies themselves become ever more esoteric, active or trading driven. Even the everyday strategist—almost all of them “Global Tactical”—essentially offers a value proposition that appears to be “we can allocate better than you can.” Probably not.
This is where Beta becomes so valuable and powerful. As we evaluate and analyze products and strategies—both for use in client portfolios and as product development competitors—we first want to know what the beta of a strategy is. So far, most ETFs were built to track a passively managed index. That means there is a beta to examine, with extensive historic data so the return and risk profile can be understood: average returns, standard deviations, etc. Without an independent, long-term returnset to understand, we won’t consider an exposure for a client portfolio. Moreover, we are believers in smart-beta. To us, it is just a passive construct organized around factors other than cap-weighting. With enough historic data to examine, we can develop confidence (or not) that an exposure brings something to the asset mix. Without beta, a strategy is closer to a crapshoot.
ETF Report has revealed in their August 2015 issue that a number of vendors are preparing to enter the ETF fray: Goldman Sachs, JP Morgan, Janus, John Hancock, Manulife and Legg Mason to name a few. We don’t expect that a cap-weighted S&P 500 ETF will be their first offering. So they will probably pursue more esoteric strategies. We wonder how far afield from beta they will stray in the pursuit of differentiation.
The same issue of ETF report also profiled a large RIA who launched an ETF based on a “premise” that seeking underrecognized companies with disruptive technologies would be a solid strategy. That’s a definite maybe and straight old-fashioned active management. Fortunately for the RIA, they have a captive distribution source—their own book—and were able to direct more than $500 million into their ETF on day one. It will take some years before anyone will know whether it was a good idea for the clients.
Beta is the main attraction. Active alpha is fleeting, unreliable and expensive. One could organize a perfectly prudent portfolio of entirely low-cost, passive, beta strategies. In fact, that is arguably the optimal way to serve clients. The largest pool of capital in the world, the Norway Government Pension Fund does just that and ranks in the 97th percentile among sovereign state funds as of June 2011. It depends on beta exclusively, with no alpha seeking strategies.
However, the constant tension between serving clients and limiting their costs, and the capitalist impulse to expand revenues and profits with higher fees always finds managers and advisors creating a rationale for esoteric products and strategies that will purportedly justify the higher fees. The trouble is—supported by mountains of data—that active, alpha-seeking strategies do not earn their keep. This simple reality has been one of the main drivers of the success of the ETF industry.
Assembling betas into full allocations is where the heavy lifting is done in the investment decision hierarchy. The asset flows into ETFs have been huge and have now attracted more entrants to the party. It will be interesting to observe the launch of products and build-out of the business. Some products and strategies will make sense, most won’t. But with enough marketing muscle, PR and captive distribution, some of them will succeed. For us though, it’s low-cost, transparent, passive beta or bust.