Content provided by Rusty Vanneman, CFA, CMT, CLS Chief Investment Officer
At CLS, I like to think that – We are Unique. We are Experts. We are Nice.
As for being unique, I was able to get even more evidence supporting that from the latest Brown Brothers 2016 U.S. and European ETF Investor Survey.
Before we get to the survey data though, as we already know, the way we build balanced, diversified portfolios is unique in the industry, as we build and manage portfolios strategically by managing to target risk levels instead of targeting asset allocations. It’s a key and defining – and important – twist to building multi-asset portfolios. It allows us to actively manage the portfolios – adjusting to changing risk and return expectations – and still be able to deliver reliable and consistent portfolio behavior.
The survey, however, got across the point that the ETFs that we select are also unique for the industry. In short, our portfolio holdings look different – a lot different – than what our competitors typically buy.
First and foremost, we are an enthusiastic user of “smart beta” ETFs (iShares® Smart Beta ETFs – The Power of Factor Investing). Currently, our portfolios are nearly 50% smart beta. Less than 20% of ETF strategists have exposure even above 20%. Over 50% have 0% exposure. CLS is definitely different.
Second, actively-managed funds make up about 10% of CLS’s AUM (assets under management). The industry average is about 1%. Again, CLS is also definitely different.
Third, regarding currency-hedged ETFs (meaning we take no currency risk as everything is hedged back into U.S. dollars), our holdings in currency-hedged ETFs is currently 15-20% of our international holdings. That is above the industry average, which is below 10%. Nearly half of ETF strategists have 0% exposure.
But there’s more.
CLS is clearly unique relative to other ETF Strategists in how we select ETFs. In short, what we look for in an ETF is different. What we emphasize and what we don’t is notable.
From the same survey mentioned above, Brown Brothers surveyed investors on the seven attributes listed below. How does CLS compare? (The CLS data is taking an equal-weighted average from surveying our own Investment Team):
But first, before we get to the list, there are two variables we ALWAYS look at and emphasize first that weren’t even included in the survey:
- Expected risk of an ETF – measured via our Risk Budgeting Methodology.
- Expected return of ETF – looked at from multiple perspectives, but most prominently from our propriety “CLS Score” which looks at multiple variables including valuations, momentum, costs, changes in risk, and fundamental and economic data.
Okay, now the Brown Brother’s survey list and how CLS differs:
- ETF issuer: While we think this is important, and we sincerely value our relationships and support from ETF issuers, we feel this is the least important of the 7 factors – and far less important than what many ETF consumers look for. It does go to show the value of branding though.
- Exact exposure of underling holdings: Meanwhile, we do consider this THE most important attribute to understand about an ETF. While this was also the top ranking for the average investor in the survey, at CLS we put far more emphasis on it.
- Tracking error: How closely does the ETF track its underlying holdings? At CLS, we think this is extremely important, and we put far more emphasis on it than most investors. To us, if an ETF doesn’t track the holdings that we expect it to follow, that’s just sloppy and a big knock against the attractiveness of the fund.
- Expense ratio: This is the second most important variable for both CLS and for the ETF investors surveyed. How we differ – we put less emphasis on it. Why? See the next attribute.
- Trading spreads: This refers to how well an ETF trades. This can be nearly as important – if not more important – than the expense ratio. At CLS, we put tremendous attention on this (it’s even a key factor in the aforementioned CLS Score) and a lot more than the average ETF investor.
- Tax efficiency: To the average investor, and to CLS, this is a given positive attribute for ETFs. There is really no significant difference in how CLS looks at it compared to the average investor. If anything, CLS puts slightly less emphasis on it.
- Historical performance: To many investors, this is one of the more important variables when picking an ETF. At CLS, while we do look at historical performance, it’s actually near the bottom of the list for us.
Bottom line, when it comes to picking an ETF, we want to know its underlying holdings, that it tracks those holdings well, that the ETF is priced right, and that it trades well. If we find an ETF in an area of the markets that offers potentially attractive expected (not historical) risk-adjusted returns, then it’s worthy of inclusion in our portfolios.
In sum, CLS is a unique money manager – in a variety of ways.