Active ETFs Take on International Investing

Scott Burns: Active ETFs take on international investing. Hi there. I'm Scott Burns, director of ETF analysis with Morningstar. I am joined today by a couple of portfolio managers for WCM Investment Management Group, Kurt Winrich and Mike Trigg. Gentlemen, thanks for joining me.

Kurt Winrich: Thanks for having us.

Burns: So, you've just recently launched the WCM Bony-Mellon ETF Focus Growth ADR, so that is a mouthful, like all ETF titles. The ticker on that is going to be AADR. Tell us a little bit about this ETF and what is going on with international and large focus.

Winrich: Well, first of all, Scott, the focus growth ADR ETF is a high quality large cap growth fund in the international space, the non-U.S. universe. And so that actually makes it fairly unique in our view, because when you look into the international space, especially when you look at indexes, you are going to find that most of them are dominated by materials, and natural resources, and financials. Not typically going to have much weight at all in technology, healthcare, those kinds of traditional growth areas. And this portfolio focuses on that, and I think that is pretty unique.

Burns: Right. Just so our watchers know, we are talking about the MSCI, EAFE.

Winrich: Yeah, that's a good example. The All Country World Index, same kind of characteristic. Whether you include emerging markets or not, you're going to be dominated by natural resources, financials. And technology, healthcare, consumer businesses are small portions of that.

Burns: So, we've got three things going on. We've got large cap, we've got international, and we've got growth. And I guess a fourth, if we want, is a focus portfolio. Why don't you talk a little bit about your investment process and how you bring all those factors together to come up with your portfolio holdings?

Winrich: Well, we're strong believers in the idea that concentration -- a concentrated portfolio, in our view that means 20 to 30 names, is the way that you actually outdo the indexes over the long run. We like to say if you're going to beat the index, you've got to be different than the index. And yet you worry sometimes about risk in concentrated portfolios. And our argument is always that if you construct it well, and if you pay attention to getting the best companies in there, you actually can have lower risks than a lot of things that are dependent on commodity prices or whatever.

So that's an important factor in how we put this portfolio together. It's high quality companies that are characterized by four big things that we think are important. That they have a great tailwind behind them, they are in a business that has real growth ahead of them for years.

An example that we think of around the world is the idea of the emerging middle class. That's why we think consumer businesses in the emerging markets, even in the developed international markets, are pretty exciting, because the middle class is growing and there's more consumption.

It's also important that these businesses have a great moat. We like the same term that Morningstar likes, the idea of a competitive advantage that's not only sustainable, but it's actually getting stronger. So we're looking for people with companies with great distribution and things like that.

And then it's important for us, and this is something that we specialize in I think, is the idea that a company has to have a culture that attracts and keeps the best people, because that's how you maintain that competitive advantage around the world.

Finally, we care what we pay for it. We are a growth manager that cares about valuation. We like to say, "Great companies, fair prices."

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Burns: So, Mike, as one of the portfolio managers, I think the sell discipline, especially in a concentrated portfolio, becomes even more important, because you're playing with kind of less open slots. Can you talk a little bit about how you make those exit decisions, which can be more important than the entry decisions?

Mike Trigg: Absolutely. Well, when we talk about our core philosophy, like Kurt was describing -- tailwinds, and moats, and culture -- any time any of those elements have changed within the original thesis, that normally leads to a sell decision. So if the moat has been breached, if the culture has changed because leadership has changed, if something about that tailwind or the relevancy of that tailwind within the world has become less important, then we're going to sell the stock out of the portfolio. It's a low turnover portfolio, so if we've done our work right on the front end, normally we're only going to turn the portfolio over about 15% or 20% a year.

Burns: Is that what you've been doing? You've been running a strategy very similar in a separate account. Is that pretty typical of what you have been doing over the past five years?

Trigg: Yeah. The portfolio has been around for five years on the separate account side, and there are 24 names in the portfolio. And close to half of those have been in the portfolio since the inception.

Burns: Wow. That is very low turnover. That should really help, I think, minimize transaction costs and taxation for investors.

Trigg: Yeah, the valuation part is really where that sort of construction piece comes in. It's sort of the ultimate risk control, if you think about it that way. We're pretty aware that part of a problem a concentrated manager can get it is sort of falling in love with a business that has done really well. And so we want to let our winners work, and we're not afraid to let a position get up to 8% or 9% of the portfolio. But normally by the time that happens, the valuation work starts to kick in, assuming nothing has sort of changed. And then we'll start to sell and try to turn the position.

Burns: One last thing. When we look at the ETF in particular, the term ADR is very prominent in there. How is the fact that this portfolio is going to really be based on ADRs only and not a broader with ordinary shares, how is that going to affect your investing decisions?

Trigg: Well, it really doesn't. ADR still provides the same currency benefit that you would get investing in an ordinary share. We are focusing on the large cap side, which we define as anything $3.5 billion in market value or greater. And once you sort of apply our quality screens financially, whether it's returns on invested capital, you're dealing with really large, well-established multi-national firms, and most of them, if not all of them, have ADRs, with rare exceptions.

So the universe is already pretty small after you apply all of our factors. And then we're finding that most of the things we are looking at do have an ADR.

Burns: Got you. Well, congratulations on the new launch. Again, that is the WCM Bony-Mellon Focus Growth ADR with the ticker AADR. Congrats and thanks for joining me today.

Winrich: Thank you, Scott.

Burns: I'm Scott Burns, director of ETF research for Morningstar. For this and other ETF news and information, please check out Morningstar.com's ETF Center and Morningstar's ETF Investor Newsletter.