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By Paul Justice, CFA | 06-29-2011 05:41 PM

Getting the Secret Sauce of Asset Allocation With ETFs

A new breed of ETFs of ETFs should allow investors to gain access to active managers' strategic bets while still enjoying the benefits of the ETF structure, says Russell's Greg Friedman.

Securities mentioned in this video
ONEF Russell Equity ETF

Paul Justice: Hi there, I am Paul Justice, director of exchange-traded fund research at Morningstar. Back in February of this year, Russell Investments purchased an obscure mutual fund, or an ETF actually, called the One fund, which was a fund of ETFs. Today I am going to talk with Greg Friedman about why the firm decided to go after that purchase and now some of the options that are available to Russell within the ETF space. Thanks for joining me.

Greg Friedman: I appreciate it. Thank you for the time. As we got into the ETF space at Russell, we wanted to be able to provide advisors two types of products, active and passive, which are two different exemptive reliefs with the SEC.

Justice: Which is quite different from the traditional ETF space where it's mainly indexed investments.

Friedman: Correct. We have the passive relief, and we've launched just recently in May, 16 new products. In February when we purchased U.S. One, the purpose of it was to gain access to a fund we think is very attractive to us, the U.S. One fund.

Justice: Which is now the Russell Equity ETF?

Friedman: It's now the Russell Equity ETF; it's an ETF of ETFs. It allows us to leverage the Russell heritage of 75 years to be able to create a very unique product that's asset-allocated. That allows us to hold the ETF of ETFs and really give the investor a active style strategy with active performance in an ETF wrapper.

We believe as we go down the spectrum of product development, we'll have three different buckets; One is passive, which we spoke about earlier; it's not going to be me-too products. It's going to be smart beta, intelligent beta, the next generation of ETFs. The second bucket is going to be the ETF of ETFs, and we purchased U.S. One in order to get access to that slice. The U.S. One fund or now the Russell Equity Fund is just that first step. We have three other funds in registration through that we'll be hopefully launching later this year that are going to have a bond component, a total-return component, and a global-opportunity component.

So we're excited that that allows us to once again leverage off of the Russell heritage to create asset-allocated ETF strategies that are active. And then in 2012 we will be able to go into more of an active ETF structure, which we're working on, but we believe at Russell strongly that an ETF needs to be transparent. So anything you will see from us in the active space will be transparent, will be liquid, reasonably low-cost, and as tax-efficient as possible. So thus, we believe that a successful ETF needs those foundations or those pillars, and we're going to hold true to that. But we're very excited about the next wave of ETF products you'll see from Russell; they will be of the asset-allocated, ETF-of-ETF strategy.

Justice: So, you're going to take some products that already exist that are low-fee and already-transparent and package them up as investor solutions deliverable through the exchanges in the ETF format.

Friedman: Correct.

Justice: So, can you talk about how the fee structures will be arranged with this? I think oftentimes the criticism we hear is that fund of funds offer layered fees, but there is a trade-off. You do get some, I guess, a more complete solution for the investor. Could you talk about how you are coming about and doing that trade-off?

Friedman: Sure. There is going to be a fee associated with holding the underlying ETFs. That's just the nature of the beast. We're going to layer on a very small management fee on top that compensates us for the special sauce, or the asset allocation. But when you add all the fees together, they are still very attractive and within the range of all other ETFs.

So we're excited to bring on an opportunity fund that's going to hold 30-plus ETFs that will give the investor a unique exposure and a very, very reasonable fee. So in the past you've seen fund families layer on fees, and that goes north of 1%. That's not how we want to operate. We are very true to the low-cost tenet of an ETF. Anything we produce will hold true to the ETF tenet, and it will be very reasonably priced, lower than 1%.

Justice: So you will be looking at low-cost, tax-efficient portfolios that are more of a solution for someone than say the singular ETFs that are available today?

Friedman: Correct. And part of the challenge we want to bring is there is 900 ETFs in the U.S. marketplace. Advisors don't know how to use those; they have different tools can slice and dice. It is a fantastic infrastructure for advisors and clients to use. But sometimes the client asks us, "Well, of the 900, which one should you choose? How would you package it? What should I do with it?"

And what we're doing is bringing the Russell intelligence to the table and saying, "Here is what you do for a global equity, bond, or opportunity fund."

Justice: Great. Now our research shows that investors are very good at picking up the right funds. It's getting the right allocation of those; that's the real challenge. So we wish you luck with that endeavor, and thank you for joining me.

Friedman: I appreciate it.

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