David Dziekanski discusses smart beta fixed income ETFs

Companies such as BlackRock Inc and Standard & Poor’s are taking a popular stock fund strategy and applying it to bonds.

For more than a decade, asset managers have been creating stock funds that track indexes designed to outperform those based on their components’ market value. Bond funds are the next frontier for index designers who use this “smart beta” approach to boost returns by taking advantage of market inefficiencies.

S&P Dow Jones Indices, a unit of McGraw Hill Financial , said it expects to unveil smart beta bond indexes in the fourth quarter.

BlackRock has not given a timetable, but is experimenting with different ways of weighting components of the broad Barclays Capital Aggregate Bond Index to produce exchange-traded funds based on new indexes, said Daniel Gamba, head of Americas institutional iShares business at BlackRock.

Traditional bond indexes are dominated by issuers with the most outstanding debt. Smart beta indexes reduce this risk by giving more weight to factors such as corporate cash flow or economic growth rates of countries.

That would skew an index toward issuers that may better service their debt, said Shane Shepherd, head of fixed-income research at index developer Research Affiliates. Some approaches more focused on returns also screen out bonds nearing their maturity date.

ETF issuers hope smart beta indexes will draw investors worried that rising interest rates could reduce the returns on traditional bond funds.

Those investors pulled some $86 billion out of U.S.-listed bond mutual funds last year, and are seeking alternatives. The trend of fund flows “has certainly favored fixed-income ETFs,” said Barry Fennell, an analyst with Lipper, a Thomson Reuters company.

With roughly $3.7 trillion in all taxable bond mutual funds and only $283.4 billion in taxable bond ETFs, there is plenty of room for growth.

“Now, more than ever, the fundamental scheme of not owning the most of a specific issuer, just because they have the most outstanding, makes the most sense,” said David Dziekanski, a portfolio manager at Toroso Investments, which focuses on exchange-traded products.

The performance of most of the nine existing smart beta funds is largely in line with the comparable indexes so far this year. One outlier is Invesco’s PowerShares Emerging Markets Sovereign Debt Fund.

The oldest smart beta ETF, which screens for maturity, is up 7.3 percent year-to-date, more than double the 3.5 percent return of the comparable, but traditionally weighted, JP Morgan EMBI Global Index. The index it tracks has had an average annual return of 8.6 percent since inception in 2007, compared with 7.7 percent for the JP Morgan index.

Smart beta products could also be more profitable for issuers, as they tend to be priced higher than more plain vanilla, broad index ETFs. A traditional Vanguard Total Bond Market ETF costs $8 in annual fees for every $10,000 invested, for example. Several smart beta funds charge about $50 for every $10,000 invested.

Mike Venuto comments on picking smart beta ETFs

Toroso Investment’s Mike Venuto says smart-beta ETFs are great tools, but it all hinges on the market environment.

Smart-beta ETFs may be all the rage, but they don’t make sense in every market environment, says Mike Venuto, chief investment officer at Toroso Investments, a New York-based advisory firm.

Arguing that the marketing spin surrounding these strategies can prevent investors from truly grasping how smart-beta funds can fit in a portfolio, Venuto warns that understanding the current macroeconomic environment is the key to using these strategies smartly.

Venuto, who was previously head of investments for Global X, now designs core asset allocation and fixed-income strategies for private wealth as well as institutional clients at Toroso. The Toroso CIO, who helped launch a multi-class mutual fund that comprises only ETFs, also stressed that smart-beta-type products are much needed in the fixed-income space.


ETF.com: Do you use smart-beta ETFs in your mutual fund?

Mike Venuto: Absolutely. We think there’s great value in what’s been classified as smart-beta ETFs. But we recently wrote a paper about smart beta because it is our understanding that everyone seems to define smart beta as anything other than traditional market-cap-weighted indexes. We felt that that’s too broad of a definition.

We agree that everything other than market-cap-weighted are nontraditional indexes, but we need to better define what subcategory of that we call smart beta.

We see it as indexes that have beta—that are focused on a traditional exposure but use something like fundamentals or dividends, or anything in that space, to reweight the index. We would put equal-weight, characteristic-based, risk-parity-based and fundamentally weighted all under nontraditional indexes, and only the latter would we call smart beta.

ETF.com: So, you define smart beta solely as fundamentally weighted ETFs. What do you see as their biggest appeal? Are they good for downside protection or to capture outperformance, or both?

Venuto: That’s an excellent question. They can be good for downside protection, or for generating alpha, but the portfolio manager’s job is to figure out what the current macroeconomic environment is, and which fundamentals should do well in that environment. These ETFs are valuable for both protection and enhancement, but it depends on the market.

Last year, for example, it didn’t matter that much. The stock market rallied 30 percent. But in a year when the market is moving sideways or down, fundamentals can matter a lot. The example that we would use is RevenueShares’ revenue-weighted indexes.

In today’s macroeconomic environment, one of the key aspects is that margins are stretched. Current net margins of the S&P 500 Index are more than 10 percent. The historical norm is around 5 percent. When we look at that, we think about the small-cap universe.

We think that what are likely to be acquisition targets are companies with good revenue and small net margins, because when they are acquired, the acquiring company can bring up those net margins.


Venuto (cont’d.): When you look at the iShares Russell 2000 ETF (IWM | A-83), you’re looking at net margins in the 7 percent range. So from 7 to 10 percent is not a very accretive transaction. But if you take the S&P 600 and reweight it for top-line revenue, you can get to net margins around 2.5 percent, which can be a 400 percent accretive transaction.

That’s what we mean by understanding the current environment and which fundamentals matter. The right fundamentals can offer downside protection as well as offer great upside opportunities.

ETF.com: Even though 2013 was perhaps not the best year for smart-beta ETFs, they attracted billions of dollars in net assets. We’ve heard a lot of projections for a market correction this year, so do you think 2014 could be a much more prospective year for smart-beta ETFs?

Venuto: Yes. They add a lot more value in markets that are volatile and sideways trending. But we believe these are really long-term tactical plays—they are not buy-and-hold-forever-type instruments. So again, you must understand the economic environment to decide whether it’s worth paying three or four times the expense ratio to own a smart-beta ETF. It has to be the right time, and that’s the job of the portfolio strategist.

ETF.com: What smart-beta ETFs do you like right now? What do you own?

Venuto: One that we own right now is the RevenueShares Small Cap ETF (RWJ | B-79), a revenue-weighted small-cap fund.

We also own a few ETFs that would fall under our characteristic-based definition. Those would be things like the PowerShares Buyback Achievers ETF (PKW | A-94), and the Guggenheim Spin-Off ETF (CSD | C-48). We like those characteristics at this time, and they’re both core holdings for us.

ETF.com: Smart-beta ETFs only represent about 10 percent of total ETF assets. In particular, there are relatively few in the fixed-income space. Is that where there’s most opportunity/need for growth in terms of product development?

Venuto: I think there’s been more growth in the equity side rather than the fixed-income side because of 2008, and fixed income has done so poorly relative to stocks. But if you think about where we are in the debt cycle, you could argue smart beta could be even more valuable on the fixed-income side.

There’s really a need for more. Market-cap weighting in bonds doesn’t make a lot of sense. We see that with the iShares iBoxx $ High Yield Corporate Bond ETF (HYG | B-75) and the SPDR Barclays High Yield Bond ETF (JNK | B-61)—they had to recently change the indexes on those funds.

The PowerShares Fundamental High Yield Corporate Bond Portfolio (PHB | B-74) is also interesting, because if you look at the top holdings, most of them are names like GM—a company that has already been saved by the government.

In a way, you can get high-yield exposure with a quasi-government backing. It’s an interesting place. We don’t have the answer on how you would make smart-beta versions of fixed income—we have some ideas, but no answers. But it needs to be done.

ETF.com: In a broader sense, what does your mutual fund asset class allocation look like these days?

Venuto: Right now we are overweighting equities and commodities, and near our minimum on bonds and cash. Our performance so far this year has been spectacular—the market is down; we are up.

Mike Venuto Featured on ETF.com article on Smart Beta ETFs

Toroso Investment’s Mike Venuto says smart-beta ETFs are great tools, but it all hinges on the market environment.

Smart-beta ETFs may be all the rage, but they don’t make sense in every market environment, says Mike Venuto, chief investment officer at Toroso Investments, a New York-based advisory firm.

Arguing that the marketing spin surrounding these strategies can prevent investors from truly grasping how smart-beta funds can fit in a portfolio, Venuto warns that understanding the current macroeconomic environment is the key to using these strategies smartly.

Read more on  ETF.com

MPT? No Thanks

Published in Financial Advisor Magazine in April 2013

Is modern portfolio theory dead? The principals at Toroso Investments LLC won’t go that far, but they do think MPT let down investors during the market pratfall of ’08-’09. And they believe they’ve constructed portfolios that more closely align with an investor’s risk tolerance and time horizon.

Toroso took shape last summer and spent the rest of the year laying the groundwork to roll out its portfolios to investors through a client base of financial advisors, managed account platforms, endowments and the pension and defined contribution markets. The firm threw itself a coming out party in February with an evening soiree on the floor of the New York Stock Exchange that featured a presentation by legendary economist Burton Malkiel and a spread that included tapas and Spanish wines.

Read more on ETF.com

Scared Stockless: How Advisors Calm Jittery Clients

Published in ThinkAdvisor.com in February 2013

… The tough conversations that dominated the advisor-client relationship during the 2007-2009 meltdown have not gone away. Far from it. Even though inflows into stock mutual funds and exchange-traded funds surged—finally—at the start of the year at the hands of suddenly bullish investors, advisors across the nation report what some are calling a historic pullback from stocks, and they are using words like “raw,” “shell-shocked” and “skittish” to explain their clients’ continuing malaise.

As Dan Carlson, chief financial officer of New York City-based Toroso Investments, puts it: “Something that’s not talked about a lot is that when we had the tech bubble blow up in 2001, everyone knew it was a high-risk environment. In 2008, it was my bank and my home that blew up. That’s a totally different psychological blow-up that people have to get over. That gets to the core of what a person’s emotional psyche can handle.”

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5 crucial tips to help you save for retirement – NBCLatino.com

Published in NBCLatino.com on February 5, 2013

Common questions financial advisors are hearing nowadays are: “What’s going to happen in the market?” and “Will social security still be there when I retire?” but in reality nobody knows, says Juan Carlos Avila, managing director and partner of Toroso Investments.

“The days of the pensions are going away, or are in real danger,” he says. “We need to save for our retirement. It really falls upon us as individuals to take care of it.”

The only thing we can do is educate ourselves to understand our own risk profile and structure an individual portfolio for saving and retirement, which will provide more consistent results with lower volatility. If we can do that, he says we will be well positioned.

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Toroso Investments™ Launched to Challenge Current Advisor to Client Interactions

NEW YORK, December 10, 2012 — Toroso Investments™, a new investment advisory firm founded by industry veterans Larry Medin, Dan Carlson, and Michael Venuto, challenges conventional advisor-client relationships by placing an emphasis on an advisor’s or a client’s economic point of view, as well as risk tolerance and time horizon when constructing portfolios.

With more than 80 years of combined experience, the firm’s founding partners bring to the business an array of portfolio analytics and wealth management experience. Larry Medin serves as Toroso’s Chief Executive Officer, Dan Carlson as Chief Financial Officer, and Michael Venuto as Chief Investment Officer.

Toroso Investments is launching in direct response to the poor performance of portfolios that have followed modern portfolio theory over the past decade. By challenging modern portfolio theory, Toroso Investments fills an existing void in the marketplace, as advisors and other financial professionals are seeking new tools to help their clients express an economic point of view, as opposed to executing a portfolio based solely on well-worn definitions of risk.

Continue reading “Toroso Investments™ Launched to Challenge Current Advisor to Client Interactions”