Warren Buffett’s latest broadside against active management has upped the pressure on an already embattled industry, but top gatekeepers have hit back arguing passive vehicles are not always the way the go.
Speaking at the Thomson Reuters Lipper Alpha Forum, on a roundtable organized with Citywire, top professional buyers from Citi Private Bank, Merrill Lynch Wealth Management and USB Wealth Management Americas mounted a strong defense of active management.
They highlighted how passive funds did not match up to active in fixed income and also questioned whether smart beta or factor-based exchange-traded funds (ETFs) lived up to their promises.
Although smart beta has hit headlines as active managers rush to innovate in this market, Ray Joseph, head of portfolio management and model solutions at UBS Wealth Management, said advisors’ appetite for these strategies was still limited.
He said they were put off by the complexity and a lack of transparency of some of these products and that where they were used within wirehouses, it was by the home office portfolio teams.
‘The only way that smart beta gets any traction is really from model solutions and discretionary portfolios,’ he said.
Jim Peters (pictured), head of global equity due diligence at Merrill Lynch, agreed that the funds’ complexity could put off investors. He added that it was wrong to see these ETFs as complete solutions, and said instead, they should be used as a part of a broader portfolio.
‘I think there is some concern about smart beta because people don’t fully understand it,’ he said. ‘Using it in a portfolio should be more of a tactical decision, rather than a bigger or more strategic part of portfolios. Even the inventor of some of the smart beta strategies has said , “you know what, I didn’t anticipate that people would use these to the magnitude that they are”, and you really need to be aware of what you’re buying into.’
Joseph gave the example of emerging market ETFs. He said he had recently scanned the available market and found returns varied wildly, depending on which factors these strategies were tilted toward and that advisors needed more education about the funds’ construction.
‘Returns were all over the place,’ he said. ‘Some of them are focused on quality, some are focused on momentum etc. Underneath the hood for all of these smart beta instruments are very complicated exposures to factors that most advisors don’t understand.’
Joseph was also skeptical of using passive funds, even vanilla index trackers, for fixed income, arguing that many of the benchmarks used by passive fixed income offerings were often flawed.
Evan Ratnow (pictured), director and third-party fixed income strategy head at Citi Private Bank, said: ‘I had one asset manager say , “Putting a core bond ETF against my active fund is like putting a first grader in a fight against a sixth grader”.’
Joseph added that index funds by their nature did not beat benchmarks, which went against the aim of his team.
‘We are focused on beating benchmarks,’ he said. ‘Every portfolio that we have, we have a benchmark that we are charged to beat and we’ll use all leverage possible to do so.’
LIQUID NOT AN ALTERNATIVE
Another type of fund to draw scrutiny from gatekeepers was liquid alternatives.
Nathan Tidd (pictured below), president of Windfactor Investment Research, said doing due diligence on these strategies could be difficult despite their mutual fund format.
He said their lack of transparency meant investors were being asked to back something without being able see under the hood.
Ratnow said due diligence was often not worth the effort for an advisor who may only allocate a small portion of a client’s portfolio to these strategies.
‘Does an advisor really want to sit there wondering what is in managed futures, when it’s only going to be 2% of a client’s portfolio?’ he said. ‘The answer is no, and that’s why I feel there’s just no hope for it in the advisor community because they’re not going to take the time to dive into that piece of a portfolio.’
He said funds were even unlikely to get large allocations at home office level.
‘At Citi, I find implementation is tough,’ he said. ‘From a research perspective, I might like long/short and managed futures, but in aggregate that’s going to be 15% of the portfolio.’
Peters said there had been high demand for liquid alts following the financial crisis but that this had tapered as equity markets rallied and investors’ appetite for capital preservation and absolute return strategies became less voracious.
‘What they are doing is comparing against an equity market that has gone straight up and so I think, what we need to see is a prolonged period of volatility [for investors to return to liquid alts],’ he said.
Merrill has 50 liquid alternatives on its platform.
Joseph was more upbeat about the use of liquid alternatives, highlighting their ability to dampen volatility, but conceded advisors had been disappointed in the past.
‘Getting a basket that’s going to be uncorrelated is getting tougher and tougher in constructing portfolios,’ he said. ‘A lot of advisors have lost faith in liquid alternatives because they haven’t met their goals and have been more correlated than they would like.’
One area of investment that has attracted interest from advisors is environmental, social and governance (ESG) focused funds.
Peter said over the past six months Merrill has been focusing on this market.
‘We are definitely looking at it a lot more than we did previously,’ he said.
Peters explained that Merrill had $11 billion invested in impact investing, up 14% since 2015, including market appreciation.
He said there was still a perception that investors must give up returns for their values, but that this was not always the case.
‘There doesn’t have to be a trade-off,’ he said. ‘It can be a positive if you’re investing in companies that really believe in their people, have good ethics and create a good footprint. Maybe there’s less litigation risk and employee turnover is lower. There are some positive things you can get from it if you’re invested over a long enough time period.’