An Eclectic Approach to ETF Managed Portfolios

Andrew Gogerty: This is Andrew Gogerty, ETF managed portfolio strategist for Morningstar. ETF managed portfolios continue to gain traction with advisors and institutions here in the United States, but this is not just a domestic trend. Other countries and other regions such as Asia, Europe, Germany, and even Canada are seeing growth in demand for these strategies. Joining me today from HAHN Investment Stewards is Tyler Mordy, chief investment officer.

Tyler, thank you for joining me.

Tyler Mordy: My pleasure, Andy.

Gogerty: ETF managed portfolios have really seen penetration with advisors in the United States in the last few years, but it’s a trend where the advisors are really leading the adoption rather than the institutions. How has it been in Canada? ETF managed portfolios are definitely available in Canada. Your firm specializes in them. What has been the adoption or the trends between advisors and institutions in your country?

Mordy: Well, Andy, I think it’s been the same experience for advisors in Canada. I call the period since 2008 a very introspective period for advisors, for institutions, and for portfolio managers. I think what happened during the ‘80s and ‘90s is that financial planning and investment management fused together, and I think the reality now is that people are learning that those are two very distinct activities.

Financial planning involving tax planning and so on and so forth, and investment management involving asset allocation, in some cases stock selection, and so on and so forth. So that introspective period lends itself to the question where can we best add value. And for the financial advisors, most definitely, I think they’re starting to focus on those things again like tax planning and so on and so forth. So, I think the trends are very similar in Canada as in the United States, and it’s a reorganizational period for the industry.

Gogerty: Well, let’s talk about that investment management piece as it relates to your portfolios. HAHN’s investment portfolios have historically had a global footprint, but there has been a material chunk devoted to the Canadian stock market, which isn’t surprising. How are you looking to deploy and distribute those strategies here in the United States?

Mordy: So, the first step in designing portfolios is always developing a strategic asset mix, and that again sort of harkens back more towards a financial-planning aspect, so designing a strategic policy mix that best matches a client’s risk/return objective. So, in Canada, we did anchor the portfolios a little bit more towards Canada and that would hold true for any country around the world.

So, the next step after that, and this is where the ETF strategist market as you know really shines, is the investment process. And in our case, and in many others' cases, it’s the tactical asset allocation. So, design the portfolio strategically and then utilize that investment management process in a tactical manner, and that process is the same. So, we can use that in Canada, the United States, Europe, wherever in the world.

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Gogerty: Let’s talk about that tactical piece, because there have been material changes in your portfolio recently. The strategies allocation to EAFE even though it is Canadian-dollar-hedged has really come down and you really kind of broadened out the portfolio a little bit with exposures to U.S. Treasuries, high-yield emerging-markets bonds, and even agricultural-based ETFs.

What have been some of the drivers there because it doesn’t seem like you’re blatantly taking risk on or taking risk off. It’s really in eclectic mix of the exposures that you have been adding.

Mordy: And I think that’s a good way to put the portfolio. It is a very eclectic mix. So, we run a process called the global macro. And global macro, probably like many other ETF strategists running this type of strategy, is a multidisciplinarian approach. So, it uses fundamental factors, technical factors and also behavioral factors. I think the third one has been really the driving force in some of the changes in the portfolios recently.

And so, when you look at the behavioral world, it’s really proliferated in academia, but it really hasn’t made its way in a significant manner into the investment management world. So, putting that into the current context, we’ve had this financial shock in 2008, and one of the luxuries of running the global macro process is that you can look back in history, you can lengthen your understanding of history and look at periods like this because we have seen financial shocks in the markets. We have seen some in the 1930s, of course. We have seen them in the late 1800s.

And so that period since 2008 has been very, very fertile ground for tactical management because it’s a very emotionally charged market. So, since 2008, the major problem is that the world isn’t getting back to normal. The familial cycle is not happening. So, we have used that where people sort of become convinced that there is a self-sustaining recovery and then risk markets fall off. We have used that sort of cycle and that cyclical aspect of markets to really be tactical.

So, some of those shifts like the long Treasury bonds, it may seem paradoxical. Why would you lend to the U.S. government at under 3% for 30 years? It seems utterly insane, but including those asset classes and portfolios is very important because you’ve got a wide variety of scenarios that could happen over the year.

So, I think that’s the real big benefit of running a multi-asset-class ETF portfolio. ETFs have proliferated. They have grown in by leaps and bounds, but it’s not because they are low-cost or tax-efficient or anything. Those are nice things but those are just beneficial features of the wrapper itself. The real benefit is that there is this breadth of asset-class exposure that folks can now use.

So what I say now is that and this is one of the ETF strategists really shine is that there is mismatch of skill sets. Who has the expertise to make decisions on Asian bonds or even things like gold bullion? And again that’s where the ETF strategist market is really doing some good for investors.

Gogerty: You talked about those behavioral aspects and they are rooted in academia. I wonder, what are your thoughts about the fact that the research was done when the technology wasn’t available? The ETF as a technology wasn’t available 10 or 15 years ago where you could actually access all these asset classes. Now that you can, do you think the behavior patterns could change going forward because individual investors didn’t have access to gold and EM 10-15 years ago. Well now they do.

So, doing your research backward kind of seeing the behavioral patterns, do you think they could change going forward because it’s now that investment set is available to a broader range of people? Or do you think the patterns may hold true going forward?

Mordy: No absolutely. I think, as I mentioned, at the outset, I think, we are undergoing an organizational and architectural shift in the asset-management industry. So, intellectually when you look at these things and you look at what academia has come with these different asset classes, it doesn't kind of square with the type of industry we have right now. So, I mean our industry, 90% of my peers run single-silo mandates. So, there are large-cap growth managers or small-cap value managers.

And I think again what 2008 and 2009 shone the spotlight on is that that’s a very rigid way of running money. So, back to the behavioral side of things, I think what folks are realizing is that, it's OK to build a portfolio with different traditional asset-class categorizations. But what behavioral finance is doing now is its shining the spotlight on risk factors.

So, it's a different way of thinking about portfolio building. So, a risk factor might be inflation as an example, and before you would have these rigid classifications of EAFE and the United States and Canada. So, I think if you can start with a different portfolio construction and shift your thinking more towards a risk-factor side, and then have a process to make sort of a repeatable performance style, then that's the way of the future.

Gogerty: It seems like you're taking a step back to something that advisors were maybe doing, but not realizing it is at the end of the day even if you picked all those single-strategy managers, it's still an outcome-based decision. Does the portfolio meet that client's financial outcome at the end of the day, that's really what they're planning for, and they plan more around risk factors, absolute risk factors, such as inflation, retirement income, and even alpha generation. And it seems like the ETF allows you to do that in one strategy as opposed to potentially siloing it out and then having to bring it all back together and look at the big picture. It seems like you can do it all at one time now.

Mordy: Right and that's interesting. And I think institutionally, if you look at the institutional market, not to pick on them, but the architecture that they've built up is very much multimanager. So, they have their silos and they pick their favorite large-cap manager and so on and so forth. So, folks like us, ETF strategists who go into institutions and talk to them, really are a threat to their business model. You think about the number of consultants and staff and systems that monitor those managers. All of a sudden we're saying we'll take over your asset allocation and we'll do in a tactical manner.

Again, it's a very budding industry, and ETF strategists are an entrepreneurial bunch. We're driven by an investment management culture, and often times it's a very small group of people that make the radical changes in markets.

Gogerty: But I would say though it seems like while the consultants may seem threatened, if you think bigger picture, I don't think that their role is diminished. I think it becomes more important because they still have to go through that manager due diligence. And does the risk return of that strategy match into that pension or endowment or big institutional account because you may still have a HAHN next to another investment manager. So, there still is manager research to be done, but I think just the shift in the focus will probably evolve over time.

Mordy: Yeah, that's a good point, Andy. Because I mean institutionally there are more forward-thinking institutions that are saying, let's depart a little bit from the silo world, and for example, traditionally they always had cash, stocks, and bonds as buckets. And now what we've noticed is that a lot of them are introducing a fourth bucket which is called opportunity or other or something like that.

So, ETF strategists just typically are after core money, but they can also serve as a complement to an existing investment program, as well.

Gogerty: Great. Tyler, thank you for your perspective today.

Mordy: My pleasure.

Gogerty: This has been Andrew Gogerty with Tyler Mordy from HAHN Investment Stewards. For more information on ETF managed portfolios, please visit MorningstarAdvisor.com. Thank you for joining us.