Editor’s Note:This interview is the final installment of a “SPY@20” series of pieces IndexUniverse has rolled out to commemorate the 20 th anniversary of the first U.S.-listed ETF. The package includes a number of interviews with industry sources as well as blogs from IndexUniverse senior executives. The stories that have run so far include the following:
- SPY@20:First ETF Changed Investing
- SPY@20: S'P 500 ' Indexing, The Perfect Mix
- SPY@20: You’ve Come A Long Way Baby
- SPY@20:‘SPDR Woman’ Still Surprised
If anyone has the perspective to take measure of what the SPDR S'P 500 ETF (SPY) means to the world of money management as it celebrates its 20 th anniversary, it’s Deborah Fuhr, the independent ETF analyst who now runs her own firm, London-based ETFGI LLP.
When IndexUniverse.com Managing Editor Olly Ludwig caught up with Fuhr recently, she said SPY is still resonating with investors and that the now-$125 billion fund is likely to remain a big asset-gatherer as the ETF continues to expand its reach.
Gazing at the future, Fuhr said that on the one hand, funds like SPY with well-known benchmarks like the S'P 500 are likely to remain important to investors, but so too is a whole new trend in money management:the so-called ETF strategist who serves up alpha-seeking strategies using relatively cheap, index-based ETFs.
IU.com:Any general thoughts about SPY’s 20 th birthday?
Fuhr: It is a product that continues to win people over, and it was challenging in the early days trying to explain to people what ETFs were and why to use them. But the SPDR specifically is a product that has really stood the test of time in a lot of ways because for almost all of the 20 years, it’s been the largest ETF.
It’s been the most actively traded most of the time also and, most years, has also received the largest net new asset flows. So, I think to be able to stand the test of time based on the dimension of tradability, the ability to go short—doing what it says it’s going to do, and being very cost efficient, is a pretty impressive testament to the product.
IU.com:What do you make of it being a unit investment trust?
Fuhr: Well, that’s interesting too, because many people felt that that structure was one that didn’t afford all of the flexibilities of the open-end structure. Coming from a global perspective where there has been a lot of concern about securities lending and using derivatives, one of the things you find is people actually are calling for a back-to-basics approach. Many investors would like to see some products where they wouldn’t have securities lending happening, wouldn’t see derivatives being used. So, the structure of the SPDR and other UITs forces them to do these things that are kind of, as many would call it, back to basics.
IU.com:So to be perfectly clear, the UIT structure prohibits securities lending; prohibits use of derivatives and it requires full replication?
Fuhr: Exactly. It’s not ideal for all benchmark exposures, but it is clearly a model that many investors today are actually asking for. We’re showing that, end of the year, SPY had $123 billion U.S. dollars. It traded about $20.6 billion every day in the month of December, and took in $15.8 billion U.S. dollars of net new assets, which was significantly higher than the next-largest ETF in terms of net new asset flows. So, based on all those dimensions, it has succeeded in being a very successful ETF, and the next product in term of asset flows was VWO [Vanguard FTSE Emerging Markets Index ETF (VWO)], taking in $10.6 billion.
IU.com:What, in all this, strikes you as important as you look back and take it all in?
Fuhr: A lot of the innovation just seemed natural as it happened. But the other thing that is important is that benchmarks are really important. I think there has been a lot of discussion about benchmarks, and clearly the SPDR tracking the S'P 500 Index means it’s linked to a benchmark that investors globally know and understand. It’s quoted in most newspapers around the world and it’s quoted on most TV shows.
So, I think that SPDRs also demonstrate the importance of benchmark in that when investors tend to start using ETFs for the first time, they often do use the well-known benchmark product for the S'P emerging markets, things that people know and understand and often use as kind of a core model portfolio asset-allocation building block.
IU.com:So where does it all lead?
Fuhr: Where do we go next? What we’ve seen is that the general investment trends are clearly pushing ETFs along so that investors embrace the idea that having some of their assets managed passively makes a lot of sense. The difficulty in finding active managers that consistently deliver alpha and the impact of not doing so when you’re in a low-return environment becomes a lot more evident to investors—especially when active funds charge higher fees. So the data coming out of S'P last year where they said that 81.2 percent of active large-cap managers in 2011 didn’t beat the S'P 500 Index is supporting the case for low-cost beta.
We are also seeing that investors in general are expanding their investment horizons. What that means is you’re finding investors moving from just looking at the home market to looking at developed markets, looking at emerging markets, looking at frontier markets, looking at different asset classes.
And the teams of people helping them invest are not incrementally getting bigger every time they add a new segment of the market or a new asset class. So, increasingly when people move to multi-asset class investing, they embrace using ETFs because it’s just an easy way to be able in any size allocation to invest in new asset classes, new markets.
IU.com:So are you taking the next step, as some ETF-industry partisans might, and arguing that beta perhaps is the new alpha? I’m thinking of some of these advisory firms who say you can use these ETF beta building blocks and construct interesting asset allocations plans that are every bit as effective as alpha generators of yesteryear, such as Bill Miller.
Fuhr: I guess I would go to that level. If I look at the evolution of users of ETFs, in the early days, the users were people on trading desks, because you could use ETFs to go long, you could use them to go short.
But I think the next thing is people who are investment strategists or “ETF strategists”— people who are running funds or separately managed accounts that are predominantly using ETFs as the building blocks. I do believe that you can create portfolios using ETFs that can generate alpha. So although they are low-cost beta used in asset allocation models, they can be used to deliver alpha. And I think it’s probably more likely for many people if they are doing multi-asset class investing that they have the ability to get their asset allocation right and often find it challenging to pick the right stock, bond or fund to represent that asset allocation. And so the ETF is I think a useful tool to be able to move to that idea that they can be used to generate alpha.
IU.com:Right. Now when you use the term “ETF strategist,” just so I understand your use of the term, that’s sort of synonymous with, say, a global macro approach—what a hedge fund might be serving up as a value proposition?
Fuhr: Well it’s funny, because it wouldn’t be my term to use. I’ve been at a conference over the past two days, and a couple of people described themselves as ETF strategists, so they’re running funds, whether it’s a fund or separately managed accounts, and they’re using ETFs predominantly to do so.
And they said this is the descriptive term that Morningstar has coined for them and their contemporaries who do this type of investing. So that’s what I’m just saying. I’m not sure I would use that term, because I would say an investment strategist is someone who talks about strategies or talks about data or talks about something as opposed to running a portfolio.
IU.com:What in your judgment are some investment scenarios where you would not use ETFs? Does this ETF juggernaut have limits?
Fuhr: Well, what everyone has to look at is, is the ETF the right tool to use in any given situation?
It really comes down to what is the exposure they want; what time horizon that they want to invest for, and what is the size of the allocation. So, I’m not going to sit there and tell anyone that ETFs are always the right tool. Sometimes it will be futures; sometimes it will be picking an individual stock or bond or an active fund. It could be a segregated account. It could be a commingled fund.
But I think what has happened is—and I think this has always been the challenge—getting people to understand when, why and how they should use ETFs, getting them to try them for the first time. And once investors try ETFs, you tend to find that ETFs do what they’re supposed to do.
And so you tend to see that investors will use them in more ways. They tend to start with part of equitizing cash or as a transition. After that, they’ll use them maybe because they want exposure quickly to something or because they don’t yet have foreign investor status. And they tend to then use ETFs as the satellite, a core, as building blocks. They tend to invest in larger sizes and they often tend to hold them for longer time periods.
There are still a lot of people who have not yet tried using ETFs, and I think that is partially because there are not as many people talking from an implementation point of view. So, a strategist says, “Now is a good time to invest in emerging markets.” Here’s how an institution might do that implementation using futures. Here is the basket of futures, the tracking risk, the fact that you would have to have a bank account. Here is how to think about using swaps, counterparty, costs, OTC transaction, not a fully funded transaction. Here is a certificate. Here are the various other things you might use and here are the various ETFs.
I think that that type of information is not as often presented today—you tend to find that people are really out there selling as opposed to providing assistance and education. And I think that has made it a bit difficult for some.
Fuhr (cont'd.): But I think going forward—so we’ve talked about some trends—I think outside the U.S. there are many investors, institutions that use U.S.-listed products, and so one of the things we do see is that regulations are encouraging financial advisors outside the U.S. to, if they want to be independent, they no longer can be paid to distribute products.
I think the rate of growth over the past three years in those model-portfolio ETF strategies has been about 800%. I think the assets in those products now are well above $50 billion. And we are also seeing that firms like Charles Schwab are trying to encourage other providers of ETFs to enter into arrangements where they can offer no-commission trading on ETFs from other providers.
So I think the retail use in the U.S. still has room to grow. The financial advisor area has room to grow because of these online brokers offering no-commission trading. And I think that the 401(k) market is something to watch, particularly Charles Schwab and others who have a vested interest in both ETFs and the 401(k) market. When you have someone who has aligned interests in both the 401(k) and ETF markets, it’s more likely we’ll see viable solutions that really work for ETFs to fit into 401(k)s, and I think that could be quite significant.
And regarding the whole thing with active ETFs, clearly there are a number of large asset management firms that want to develop products more in the active space. How we define these things going forward will probably change who is using them, because most of the users of ETFs to-date have really embraced ETFs as low-cost beta tools and have not looked for alpha out of them. So it probably means the user base expands and changes.
IU.com:Right. And you’re making allusion to large players like Fidelity Investments, for example, or are there others that come to mind as you formulate that thought?
Fuhr: Yes, and firms like T. Rowe Price, and Hartford and Legg Mason—there is a whole list of firms that have filed for active products. Also, Eaton Vance has an idea that is in the nontransparent active space, and so do Guggenheim and BlackRock.
IU.com:Yes, it is a long and illustrious list. Now, to bring it back to SPY and the test of time that it has survived—you don’t see that diminishing? You don’t see any compelling logic as to why it might run its course and become kind of a nice artifact of money management history as opposed to remaining a vibrant tool in an investor’s toolbox?
Fuhr: No. Even when people have come out with less expensive S'P 500 products that do securities lending and that reinvest dividends—and which, in a rising market, you would say would likely have slightly better performance because they don’t have the cash drag—you haven’t seen those products take away significant assets.
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