Andrew Gogerty: Advisor demand and interest for ETF managed portfolio strategies continued at a strong clip in 2012. These managed account strategies tracked by Morningstar grew a robust 60% last year to $63 billion through the end of the year. Joining me today for a perspective on this trend from inside the wirehouses is Justin Demko, senior portfolio manager for UBS Private Wealth Management and manager of the UBS global equity income and global balanced income Strategies.
Justin, thank you for joining me today.
Justin Demko: Thank you, Andy.
Gogerty: So, as I said in the intro, this space is growing. Education among advisors and RIAs is really out there, especially in the independent broker-dealer space. But there is a parallel shift going on inside the wirehouses where FAs and private wealth teams such as yourselves are also looking at these strategies as opposed to the historical or traditional investments. What's kind of driving that shift inside the wirehouses looking at ETF managed portfolios?
Demko: I think if you look at the history of what solutions the advisors have had to offer their clients and the model in which we've used in over the last, say, 15 years or so primarily using managed accounts and mutual funds, a number of advisors have looked to have a solution that focuses more on expanding out the number of options that they have to bring to their clients. So, with ETFs and our team, we use that as a core offering within the equity side, whereas we will use from a satellite standpoint managers and mutual finds around that core of ETF portfolios.
Gogerty: What about in terms of being inside a wirehouse, you essentially have two options. You could build it yourself or you could tap into a "home office" or like centrally provided ETF strategy. What goes into making that decision for a team inside a wirehouse such as yourself?
Demko: The good thing about being at the wirehouse is you have a lot of intellectual capital at the firm brought to the table. So, what I've seen there is a lot of advisors have used the models that are created primarily from the ground up through, for example, UBS, through the UBS wealth management research department. And an example of that would be a high-dividend strategy where the research department is doing the research on the single-issue stocks and then that's being fed up to a trading platform that the advisors can then use to implement across their portfolios.
Gogerty: What goes into going out and talking to these financial advisors? Obviously, your team has decided to go the latter route and build your own ETF strategy rather than tap into a prepackaged solution.
Gogerty: What went into that process in not only making that decision, but then deciding to take it to not only your direct clients, but other financial advisors inside your wirehouse network?
Demko: So, for us, when we made the shift from primarily using separate account managers on the equity side to using an ETF portfolio, we still use the research coming out of UBS that helps guide us for the asset-allocation decisions. That's the primary starting point for our asset allocation. Once we have the asset-allocation in place, we then use a covered-call option overlay on top of that which is proprietary to us.
In terms of the advisors using our strategy, they have, of course, the option at UBS to go a number of different routes. What we've shown over the last five years through skillfully managing the portfolio on the ETF side and on the option side with an alpha of about 6.85% annualized over last five years is, we found that advisors like to be able to tap into another team that has experience with private clients where they can then use our strategy or be partners with us to then bring to their client base or also use it as a tool to go out and acquire new clients.Read Full Transcript
Gogerty: You had mentioned options as part of your strategy, which is something that even ETF managed portfolio strategies outside the wirehouses are using to some degree from time to time. What is the main goal of the options overlay in your strategies? Are you looking at tail risk or kind of that unknown or known-unknown, or are you using it to generate income and dampen volatility? What's kind of the primary goal of your strategies in using the options?
Demko: We started off in 2007 designing the strategy and then implementing in 2008. Now, as you know, there has been a lot of volatility over that time period.
Gogerty: A little.
Demko: Having a covered-call strategy has been very helpful in generating income into the portfolio.
Demko: So, primarily what we do is, through the selling of 30-day covered-call options we generate income on a monthly basis, and then that income is then either distributed out to clients who need cash flow or it's reinvested. And through compounding, we end up buying more shares of the underlying ETFs in the strategy which ultimately over time results in higher returns as the market moves up over a longer period of time.
Gogerty: Basic reinvestment, compounding dividends is kind of how historically people have done with their mutual fund distributions typically.
Demko: Correct, exactly, additional share repurchasing. When we look at the strategy, we like to look at it as a pyramid. So, in order to get to that top of the pyramid where you're hoping for alpha or outperformance, the base of that pyramid is asset-allocation first, and then a look at dividends, and then consistent rebalancing, and then finally that option overlay that creates the additional income into the portfolio which for us has led to our alpha.
Gogerty: There is a tactical component. Now, while you're not wide-ranging where you'll go all the way to cash or gold, all the way to dividend-paying emerging-markets small caps from month to month, there still is a tactical component to your strategy, where you are looking to position it as the best relative opportunity for your clients. What are some of the changes either in and out of the portfolio, say, over the last three to six months that you've made? What's the flavor of the portfolio now? What are you looking at from either an asset-allocation or an investment opportunity perspective?
Demko: I am glad you asked that question. From a tactical standpoint, we follow the firms' modeling in terms of what they are putting out from an asset allocation standpoint, which they publish on a monthly basis. Part of what has led to our success and our outperformance is the fact that we haven't made large moves within the portfolio. So, if you look at our allocation now, even from the inception going back five years, you won't see a drastic move in or out of any asset classes to a large degree. It's more fine tuning. If you've seen an asset class run up over time, you're going to start paring that down. Consequently, if you've seen an asset class sell off over a period of time, we might take that up 2% or 3% in terms of the allocation.
Gogerty: In addition to your tactical or kind of a hybrid model where you have a strategic model and you're rebalancing it, volatility is obviously a key component in option investing. What has that volatility done to the option overlay over the last say three to six months or even over the last year?
Demko: Recently the VIX has been quite low relative to what we've seen over the five years that we've been running the portfolio. What we've found though is as long as you stick with the discipline of writing out of the money calls on each individual asset class that we manage, you end up still producing meaningful income. Now granted the income in 2012 and 2013 is very different than the income we were receiving in 2008 and 2009, but the difference is, is with the low volatility what else are we seeing? We're seeing an increase in the underlying equity market, right? So, we're still making it up on the appreciation side of the underlying ETFs.
Gogerty: So, it's still a total-return focus at the end of the day, not really just separating the portfolio just for income or just for capital appreciation. The components are actually working together and can be complementary.
Demko: That's exactly right. What we've found is that if you maintain the consistency of selling out-of-the-money covered-call options on these individual asset classes, over time you're going to create that small amount of income. But through the compounding effect, it's going to turn into a meaningful outperformance given the fact that in some markets, if you're writing those calls too close to the money, you're going to miss out on the appreciation. So, you're absolutely right. Total return is really the focus at the end of the day.
Gogerty: Great. Justin, thank you for your perspective and your time today.
Demko: Thank you very much.
Gogerty: This has been Andrew Gogerty talking with Justin Demko from UBS Private Wealth Management. For more information on ETF managed portfolios, please visit out ETF managed portfolio center on Morningstaradvisor.com. Thank you.