The S&P Dow Jones Indices Financial Advisor Channel has followed the progress of Exchange Traded Fund (ETF) Strategists with interest for over four years. In fact, we have developed close working relationships with many of those firms. They are often champions of indexing; power-users of ETF use in portfolio management. Whether one tracks ETF strategists by assets under management (AUM) or inflows, the last four years have shown that business has been good for these firms as a collective body in asset management. That track record of double-digit growth hit a speed-bump in Q3 2014. According to Ling-Wei Hew of Morningstar, AUM for ETF strategists fell 6% in Q3, a reversal taking them back to 2013 levels.
Why the outflows? Blame it on the long bull run of the S&P 500. Ling Wei Hew reports in Q3 2014 ETF Managed Portfolio Landscape that 33% of ETF strategists follow a US equity strategy. In this year and last, many of these strategies have underperformed the S&P 500.
Is the S&P 500 a fair benchmark for these ETF Strategists? Many that I have spoken with would prefer a different benchmark. The ubiquity of the S&P 500 as a benchmark means they end up choosing it themselves anyway or it is forced on them by default in the way they are ranked and analyzed. Being benchmarked against the S&P 500 is appropriate if the objective of the fund or portfolio is US large cap exposure. S&P DJI has proposed that kind of benchmarking and comparison for years in our S&P Index vs Active (SPIVA) US scorecard. But benchmarking tactical or risk-managed portfolios against the S&P 500 fails to provide the same level of “apples to apples” comparison which is the hallmark of our SPIVA and Persistence Scorecard research.
Why isn’t the comparison of the S&P 500 to a US risk-managed portfolio an “apples to apples” comparison? The Chief Investment Officers and portfolio managers of a risk-managed portfolio seek to provide risk-managed exposure to equity markets. Risk-managed usually means having a goal of limiting asset loss during protracted or recessionary downturns or preventing Black Swan-type risks of loss. This goal of risk management is sought simultaneously with the goal of capturing as much equity market growth as possible. By contrast, the S&P 500 seeks to be the best single gauge of large cap US equities. So do the outflows in US Tactical and risk-managed ETF portfolios suggest that clients have changed their mind about the value of risk-management embedded in these strategies? The S&P 500 Total Return Index (dividends included) has returned 76.83% over the last 3 years and 122.2% over the last 5 years. The timing of these outflows suggests an emergence of a second risk that investors may be concerned about – the risk of missing out.
The cost of risk-managed portfolios can be compared to the cost of insurance. In a similar way, one can imagine that the more risk-sensitive an investor is, the more “insurance” they might want. To carry the insurance analogy one step further, imagine an auto driver looking back at his past five years of safe driving and thinking that 5 years of insurance premiums were paid for with no benefit. With no laws or regulations requiring “insurance” for portfolios, an investment in a risk-managed portfolio must be perceived by the investor as more of a benefit than a cost. The value of risk management must be hard to communicate after years when protecting against that risk didn’t seem to matter…in hindsight.
This is the first post in our risk management series. Stay tuned for more posts from guest bloggers on this topic.