The expansion of the ETF universe continues to spawn innovative instruments for mainstream investors of all styles and sizes, making it easy for virtually anyone with an online brokerage account to build a truly globally-diversified portfolio. With innovation also comes complexity however, and the towering lineup of over 1,400 exchange-traded products may seem intimidating at first glance. Quratulain Hashmi, President of Razor Hedge Investment Management, is a passionate advocate for the retail investor, and her firm’s vision centers around the notion of democratizing access to institutional investment opportunities. Quratulain recently took time to discuss how her firm utilizes ETFs and takes a creative approach in bringing professional investment management strategies at the fingertips of self-directed investors [see Free Report: How To Pick The Right ETF Every Time].
Quratulain Hashmi (QH): Razor Hedge is an investment management firm that aims to level the playing field for the individual investor and independent advisors versus the big institutional investors. In short, we aim to democratize access to institutional investment strategies while raising the bar on transparency and integrity in the investment management process. Our innovative investment platform answers the basic questions: How to invest prudently? How to efficiently execute portfolio over time? How much to save for retirement? How much to take out in retirement? We simplify investing and help individual achieve their long-term goals.
ETFdb: Explain the basic idea behind the Razor Hedge Prudent Manager Indexes.
QH: The Prudent Manager Index (PMI) portfolios provide an appropriate long-only global asset allocation benchmark for any level of risk exposure. PMI are asset class index portfolios that are well diversified, reduce the excess volatility of stock picking and provide consistency of returns relative to the top institutional asset managers. The portfolios are allocated over a broad set of global equity, bonds and alternative asset classes that provide the most liquid investments opportunities. The index portfolios reflect the consensus view of the top 500 institutional global investment managers. This strategy reduces the idiosyncratic risk of the individual advisor that comes from their unique and divergent economic views. The PMI provides 101 portfolios that span the entire risk/return frontier from 0% to 100% allocation in risky assets, allowing the investor to choose just the right risk level based on their unique needs.
ETFdb: What was your inspiration for developing this set of benchmarks?
QH: We set out to level the playing field for individual investors who traditionally would not have access to top institutional advisors. The asset allocation strategies available to most individual investors are tied to a rule of thumb approach and may not meet the specific needs of the investor. We wanted to build an investment strategy that allowed the retail investors to achieve returns consistent with a basket of top institutional managers [see 101 ETF Lessons Every Financial Advisor Should Learn].
ETFdb: Why does it make sense to use the ETF wrapper for investors looking to pursue this sort of strategy?
QH: Index ETFs generally provide better trade off on convenience, transparency, flexibility and net returns over mutual funds. From an operational perspective ETFs provide lower trading cost, have lower portfolio churn and have lower tracking error. Accordingly index ETFs make sense for the passive long-term investor
For taxable portfolios the advantage of ETFs is even greater. ETFs generally offer more efficient tax structures than mutual funds. The lower turnover ratio of ETFs reduces the taxable gains distributed to investors. Our innovative tax managed portfolio system aims to increase after-tax returns for investors. The strategy uses ETFs tax-loss harvesting to selectively realize capital losses and rotate to other index ETFs with similar risk exposure.
ETFdb: How might this strategy fit into a portfolio? Would you consider this as a core, or more tactical holding?
QH: Our PMI asset class portfolios can serve as the core strategic portfolio for any investor or advisor. We answer two fundamental questions.
The first question is what asset classes should one use? The PMI portfolios picks just the right set of asset class indexes that can result in the most diversified portfolios for any given level of risk. We start by selecting the appropriate asset classes that represent unique risk factors in the global financial markets. We have analyzed over 1500 investable indexes and from these found that just 20 asset classes indexes are most liquid investable and explain nearly all of the expected returns of all the other indexes and global investment managers. These asset classes serve as the core building blocks of our portfolios.
The second question is how to allocate between these core asset classes? The top institutional investment managers spend tremendous amounts of financial resources in deriving their unique economic views and carefully constructing their asset allocation. Our team has developed a predictive style analysis technology that tracks the largest 500 global mutual funds and calculates their daily changing asset allocation. The PMI is able to harness the intelligence of all these top managers and provide a prudent benchmark asset allocation for any given level of risk. These benchmark portfolios can serve as the core of any long-term investment strategy.
ETFdb: Explain the basic idea behind Razor Hedge taxable portfolio management with ETF tax-loss harvesting?
QH: Our taxable portfolio management strategy seeks to maximize the after tax return. We select appropriate tax-advantaged ETFs and manage them efficiently through our proprietary system [see Tax Loss Harvesting With ETFs].
We select ETFs that minimize short-term capital gains distributions thus reducing the tax drag on the portfolio. We also shift some of the portfolio fixed income allocations to ETFs that invest in tax-advantaged municipal securities. The Razor Hedge taxable portfolio system dynamically tracks the asset class risk exposure of the appropriate target PMI portfolio. The system selectively takes advantage of capital loss harvesting opportunities when the benefit of the action exceeds the associated costs. The system takes into account appropriate IRS laws and regulations when making the decisions.
ETFdb: There are some out there who believe ETFs have gone too far from their initial intention of offering broad-based exposure to buy-and-hold investors. What’s your take on the innovation in the ETF industry over the last several years?
QH: We are advocates of passive index ETFs that are tax efficient, have low expense ratios and low portfolio turnover. The biggest economic value provided by the highly liquid index ETFs is that they are the source of price discovery of various risk factors that investors have reason to care about. Importantly, these index ETFs allow retail investors to efficiently build portfolios that hedge and diversify their pre-existing risk exposure. For example, a person who works in a highly cyclical industry might want their investable portfolio to diversify away from cyclical stocks. However, we remain cautious about the exotic investment strategies behind some of the more innovative ETFs and ETNs. It is not obvious if these products are appropriate for retail investors.
Bottom Line: Self-directed investors will continue to embrace the exchange-traded product structure as the preferred ”building block” for executing cost-efficient strategies over the long-haul given its inherent advantages over traditional mutual funds. Innovation in the ETF industry has undeniably democratized the investing process, opening up the doors to strategies and asset classes that were previously out-of-reach for most individuals.
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Disclosure: No positions at time of writing.