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Navigating Beyond the Bounds of the Style Box

Paul Justice, CFA

Paul Justice: Navigating beyond the bounds of the style box. Hi, there. I am Paul Justice, director of exchange-traded fund research at Morningstar. Today, we're going to talk about some of the investment discipline ETFs that were brought on-board by Russell Investments recently.

I am joined by Mark Roberts, director of product development over at Russell, and Rolf Agather, director of research within the firm's index group. Thank you for joining me gentlemen.

Mark Roberts: Thank you.

Rolf Agather: Thank you.

Justice: Now you now have these six investment discipline funds that are available to investors, and they really go from one far end of the Morningstar Style Box to another conceptually, but may not sit in any one area at any point in time. Could you talk about kind of the outer bounds of where these ETFs fits and what falls in between?

Roberts: Certainly. The six investment discipline ETFs do fall along the spectrum from aggressive growth at one end, consistent growth, growth at a reasonable price, equity income, low P/E, and a contrarian approach. So, you can see that sitting across the spectrum from value to growth, but there's much, much more going on behind the scenes here. This is not just the growth value spectrum sliced six ways.

Justice: Yeah, as most investors know, this is a nuanced approach, there's nothing that's entirely pure along the spectrum unless we're doing some sort of benchmarking. Could you talk about kind of the two barbell ends on where they fall? So we're really looking at the contrarian fund right now and the aggressive growth fund and what principles or qualities these funds are going to have.

Roberts: These are really designed around our 40 years of manager research and understanding what managers in those styles or in those disciplines would try to do. So, at the aggressive growth end of the spectrum, you're looking for high-sales-growth, high projected-earnings-growth-type stocks. On the other end of the spectrum, you're looking for undervalued stocks in kind of a deep-value-type space, but also with a relatively low price/book ratio. So these are stocks that have the potential to turn around with time on the contrarian end.

Justice: Now are either these dependent upon a single variable? It sounds like if you're doing a lot of research on active managers, you're taking a multifaceted approach to segment these buckets.

Roberts: Absolutely. They are distilled into a rules-based methodology, but they do follow a number of different criteria, both accounting-based and rules-based criteria, to get to their output.

Justice: Now when we come into the middle we have the intersection here between growth at a reasonable price versus equity income. Could you talk about why those strategies might be similar in some constructs but really what separates the two?

Agather: Sure, I think it's interesting, because even though growth at a reasonable price has the term "growth," you'll notice the reasonable price element starts to bring up connotations of value. And I think it does represent that there are investors who potentially also recognize that they want the bargain, even though they are interested in growth by sort of a typical definition.

So, it is really that mixture of both viewpoints. So from Russell's point of view, it's actually more sort of a market-oriented construct. So, as we talked about the spectrum, Russell would really look at GARP managers as being a little bit more toward the middle, maybe just slightly biased toward the growth side.

The equity income discipline is interesting. Strictly speaking it's not looking for high yield, but I think if you actually look at typical growth strategies, a lot of times growth mangers purposely leave out companies that pay dividends. It's a view that that's money going out to the shareholders and the firms can't invest that in the company.

So, equity income really is bringing income back in, so, strictly speaking, it's not looking for the highest-yielding stocks, but its really bringing that back into the particular strategies, trying to find companies that potentially have good growth prospects but also pay income.

Justice: Sure and being indifferent kind of lends itself to a total-return approach rather than something that will just target a higher yield and anything else.

Agather: Exactly.

Roberts: Absolutely and the delineations between each are critical along that spectrum. So aggressive growth, as I said, is going to look for companies with high sales growth and high projected earnings. Consistent growth is going to look for exactly what it says, more consistent growth. So the team going to apply filters around earnings volatility and look for low earnings volatility, as well as growth-oriented stocks.

Justice: So we look at the growth funds. What would the typical client profile be, somebody who is really debating they want some growth in their portfolio and perhaps are looking at the aggressive growth fund and the consistent growth fund? What would be the make of the investor who would move toward one or the other?

Roberts: So, this is going to be a very typical advisor-type discussion with their client. Advisors are going to want to express some conviction and head toward one end of the spectrum or another or perhaps anchor on one of these disciplines over another. One of the things that we found very interesting was the increased fiduciary burden on advisors these days and the nature of the transparency, not just in the ETF structure itself, but in the name.

So, for advisors to have a conversation with their clients around pursuing a consistent growth strategy and then for the clients to see an ETF, which is a fully transparent, low-cost vehicle, but also to see the statement from the advisor come and read Russell Consistent Growth ETF, that draws that transparency through in a way that makes that advisor as a fiduciary and the client feel good.

Justice: So it's a simple screen brought forth in an index concept and issued to the markets through the ETF channel, giving them tax efficiency and typically a low-cost product solution.

Roberts: That's right.

Justice: Great. Well thank you gentlemen, for helping to explain the spectrum of the new Russell investments.

Agather: Thank you, Paul.

Roberts: Thank you.