Scott Burns: Hello, there. I'm Scott Burns, Morningstar's director of ETF research, coming to you live from Morningstar's ETF Invest Conference.
Today I'm joined by SSgA's Dan Farley, and we're going to talk a little bit about tactical versus strategic portfolio tilting.
Dan is the global head of investments for SSgA's Multi Asset Class Solutions team, and he oversees over $190 billion of institutional money worldwide.
Dan, thanks for joining me.
Dan Farley: Good to be here.
Burns: So Dan, one of the hottest topics in the investing space right now is the role of tactical decision-making in portfolio, especially when you overlaid it on what is generally a strategic portfolio allocation.
Burns: What do you guys practice at State Street?
Farley: So, within SSgA, we've been running tactical money for decades now. And so it's an area that we believe there are market inefficiencies that you can capture with good disciplined process.
I think that tactical asset allocation, like any active strategy, relies on a manager who has a good skill, has good ability to identify trends in the marketplace and move to be able to capture and take those trends.
So, to the extent an investor is looking for an additional source of return, tactical could or should be something they should consider. Of course, there is lots of different ways to implement tactical.
Burns: Right. And I think that's part of the confusion out there, "what is this tactical shifting?" Are we making real active bets buying individual securities or is it more of a tilting as you kind of alluded to earlier?
Farley: I think it will depend on the manager. In our case, we tend to make it at the asset class level, so we're not making the Coke versus Pepsi call, but rather, do we think that U.S. equities will outperform emerging-market equities that bonds will outdo small cap, things like that.
I think that the level of risk that a manager takes is also very important, as you think about this. Some managers will take a very active, almost global macro hedge fund type approach, where they're making very, very large swings in the portfolio, and to the extent they have skill and that can be rewarded, fine.
But that really puts a lot more risk to the investor perspective that if and when they are wrong, you have a period potentially of significant underperformance; versus some managers, and this is more the camp that we fall in, which are much more risk controlled and will make moves within say, plus or minus 10% or plus or minus 20% around the client's given benchmark.
And that means we can make tilts, try to capture some of those inefficiencies, but at the same time not deviate too far from the overall portfolio.
Burns: I mean in a lot of ways, it sounds like you use tactical asset allocation as much to reduce risk as you do to increase return?
Farley: I think it depends on the market environment, but that is absolutely true. You know in some cases those two things go hand in hand; if in 2007-2008, you were underweight to equities, it was a return enhancer but it was also a risk reducer.
Burns: And as a firm that's been practicing tactical asset allocation for as long as SSgA has, what was the biggest thing that the events of 2008 and 2009 really drew out for your process?
Farley: I'd actually go back to the events of 1999 and 2000, quite frankly, that we learned a lot from there. So, our process is largely quantitatively based. And that means that over long periods of time it gives us good signals to try and analyze all the data across the world and have a view on various markets, which is a great tool to have. But we also understand there are going to be periods where models will break down.
And if we go back to 1999 and 2000, and we think about what happened to a lot of tactical managers, which was at valuation played with large component to their process, and in 1998 tactical managers were shifting out of equities because the S&P 500 looked too expensive.
Farley: They were shifting from U.S. stocks to non-U.S. stocks, both of those moves from '98 to 2000 were bad moves, and performance suffered very significantly. Now, they turned out to be ultimately right, if you could have waited for the event to have happened. And so…
Burns: Right. Given a long enough horizon, right, they all work out...
Farley: Fair enough. That discussion in the institutional memory back to that time period was germane to a lot of conversations that we had in 2008 and 2007, which was, let's not fall into that valuation trap again. Let's identify that analysts probably are going to be slow to bring down their earnings estimates, so the P/E ratio is not as attractive as perhaps it looks when you calculate it today.
And so, I think using that kind of institutional memory and having been in the marketplace long enough, you start to understand where the process works, where perhaps it doesn't, and where you want to challenge how you approach the money management philosophy.
Burns: Got you. Now, being that this is the ETF Invest Conference, I can't let you go without asking, in your business, in your portfolio construction, how are you using ETFs, and what's maybe one of the more unique ways that you are using ETFs that folks on Main Street may not really know about?
Farley: Sure. So, I think in general the ETF usage by institutions and by us specifically has increased dramatically. Our clients have traditionally used a lot of institutional commingled funds, but we are more and more seeing portfolios that are made up of entirely ETFs, and that has been just a great way to be able to get exposures to marketplaces--very liquid. And given that the growth of the breadth of types of ETFs over the last several years, it absolutely makes it possible. We couldn't have been doing this four or five years ago, because there just wasn't as much product out there. So, it really has allowed us to do that.
I think the area that we're using ETFs probably less traditionally than a mainstream investor might, is with very large institutional investors who are looking to get immediate exposure and liquidity to an asset class, perhaps they're looking to hire a direct real estate manager, but they want to get that money exposed to real estate right away. So, we might use a REIT ETF to do that.
And so, from a liquidity exposure management perspective, we start to see the use of ETFs really being a very traditional mainstream approach for institutions now.
Burns: Well, Dan thanks for taking the time.
Farley: My pleasure.
Burns: And I am Scott Burns reporting live from the Morningstar ETF Invest Conference.