Trends in ETF Managed Portfolios

Andrew Gogerty: Hi, this is Andrew Gogerty, and we are here at the 2012 Morningstar Investment Conference. We're talking today about ETF managed portfolios. Joining me today is Tom Fox, chief investment officer from Quantitative Advantage.

Tom, thanks for joining me today.

Tom Fox: Thank you very much.

Gogerty: So, for ETF managed portfolios, Morningstar is saying 50% of assets are in ETFs in the portfolio. Quantitative Advantage uses all ETFs, so obviously you know your firm applies. These strategies and Morningstar's database have seen tremendous growth in the last two years and even three years. What are some of the key reasons that financial advisors have been rotating client assets into portfolios of ETFs and allocating capital to firms like yours? These aren't individual investors calling QA and opening an account. It's a financial advisor or an institution allocating capital to firms such as yours. What's kind of driving that shift in the advisor market?

Fox: I think there is really two drivers. One, is the proliferation of ETFs themselves, and the other is the market volatility that we've been experiencing.

Gogerty: So, your 2002-, your 2008-type of volatility?

Fox: Really, it goes back 12 years when we first came into the technology bubble burst, and so we had 2000, 2001 and '02 bear market. Then we went into the financial crisis of 2008, and now we're in the Southern European risk-on risk-off crisis. So, we've had increasing volatility, and what advisors are looking for, what their clients are looking for is a better return experience. So, they are trying to smooth out returns and tactical money management, which is now easy to do in the ETF market because we have so many different places to go to. I can go all over the globe [and get] easy access, liquidity, and transparency. There are so many of these things that make it really easy to build these types of strategies.

Gogerty: You had mentioned a tactical [strategy], your peers along with Quantitative Advantage have different degrees of tactical. And Quantitative is a little bit different in that you offer stand-alone strategies along with a multiasset global solution for advisors. How are advisors combining these, or kind of what's resonating more with them right now? Is it taking two QA's and putting them together, or are they looking for a combination of the two or even a multiasset?

Fox: I think definitely, there is a move by advisors to combine managers together. Now, sometimes they'll do that with the multiple strategies that we offer. We have traditional tactical strategies that may go growth-to-value, large-cap, mid-cap, small-cap, or a bond rotation, but they're all within the traditional asset classes. Then we have our multi-asset-class strategy which is tactical all-market, and that can go to currencies, commodities, real estate, and much broader, even inverse. So, we're finding that advisors want to combine these two different strategies together, and by combining you get maybe one zigging while the other zagging. Overall, you're getting from point A to B in a much smoother way.

Gogerty: So, it's almost like they still want the core to be something that historically people understand or recognize, where it sounds like tactical all-market is almost the opportunistic sleeve or the satellite part, and they are looking for those more siloed asset classes to be kind of the core of the portfolio.

Fox: I'd say right now it's true, but we're seeing emerging interest in increasing the allocations towards more of an alternative strategy.You're seeing that in the institutional realm. If you get into the academic endowment funds, they are right now over 50% toward alternatives. And so it depends on what your presupposition is, and we're seeing--and I think this is going to be a trend--that maybe the core, which is right now traditional, that might eventually down the road be alternative, and your core might be satellite. So, that depends on the where the advisors are, but certainly today, it's more tilted toward the traditional.

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Gogerty: It seems like it's where kind of education and technology are going to go because I think back four, five, or six years where REITs were considered an alternative where now they are considered almost the core part of a portfolio. Given that that tactical nature that you have and the ability to go, what are some considerations, or what do you think kind of are the key understanding points that advisors should have, when they are considering moving from a more strategic allocation to ceding some of that responsibility to a firm such as QA?

Fox: I think first of all, they have to understand the role that we would play or the manager like us in their overall portfolio. Our role is to deliver a return pattern that's different than what maybe their experiencing in a more static or buy-and-hold strategic-type portfolio. We're not going to act like their portfolio, such as if their portfolio acts well and when equity markets are rising, and a tactical, more alternative type of strategy doesn't go up with equities at the same pace. So, they have to understand that each has the role, and it's really over a full market cycle by combining those two together--as long as they know what that role is--that we're not trying to have equity returns in up-market and no downside. Because most of these strategies, the ones we devise, are to bring stability and lower downside. To have that, you can't have your cake and eat it too, but you got to know its role in the long term.

Gogerty: It sounds like setting that advisor into understanding what QA does and even your competitors and then being able to relay that expectation to clients is going to be key to making sure that it's mutually beneficial, the outcome. Both people expect it, and they understand where it's coming from.

Fox: That's right. I think it comes to education. Do they really understand what the purpose of a strategy that will deliver a different return pattern means? It impacts the overall risk-adjusted return. It impacts the up capture and down capture, and it's [asking] how does the whole package come together that at the end of the day that their clients are going to be happier.

Gogerty: Great. Thanks for the insight. It's very interesting and definitely a growing space and an interesting part for Morningstar to be involved with. This has been Andrew Gogerty at the 2012 Morningstar Investment Conference talking with Tom Fox from Quantitative Advantage. For more information on Morningstar's ETF managed portfolio database, please go to advisor.morningstar.com and click on ETF managed portfolios. Thank you.