Sandy Rattray, Man SS

The role of value added strategies

By James Williams – Although long associated with passive management, the ETF industry is fast evolving as active managers look to leverage the potential of the ETF format. Already, 31 active managers have sought permission from the SEC to provide active ETFs; the PIMCO Total Return Fund, launched 1 March 2012, is just one of a number of successful launches.

Last week, MJ Lytle, Managing Director, Source, one of the industry’s leading providers of Exchange Traded Products, hosted a press conference in London to discuss the role of value added strategies within the ETF space. The three speakers included: Hugh Cutler, Head of Distribution, Legal & General Investment Management; Howard Chan, Product Manager, PIMCO, and Sandy Rattray (pictured), Portfolio Manager, Man GLG Europe Plus Index at Man Systematic Strategies (Man SS).

Smart beta funds and active funds are building momentum as managers look to go beyond delivering pure benchmark-driven beta returns. The US now has 72 smart beta funds running USD31billion in AUM, whilst Europe, still someway behind, has 27 such funds running USD7billion in AUM.

To illustrate the growing acceptance of niche, smart beta strategies, Lytle commented that Source had raised EUR184million of net inflows this year into broad-based passive MSCI Europe tracker ETFs, while at the same time Man GLG had attracted EUR190million into its Man GLG Europe Plus Source ETF.

Howard Chan touched upon some key points in the fixed income space and how PIMCO was developing a suite of GDP-weighted indices to deliver outperformance. He stressed that investors need to take a smarter, more forward-looking approach to investing, given that the bond market landscape is changing.

“The picture for 5-year CDS spreads is more mixed. It’s now cheaper to insure Brazilian debt than Italian debt,” said Chan. He then went on to explain that PIMCO has developed its Global Advantage Bond Index (in addition to inflation-linked and government bond indices) to reflect this need for forward-thinking strategies. With traditional market cap-weighted benchmarks, because they are most heavily weighted towards the largest issues and issuers, they force investors to lend to countries with the highest indebtedness and the lowest yields.

PIMCO’s Global Advantage Bond Index uses a rules-based approach, providing better diversification by “avoiding habitual debtors and re-allocating to higher yielding bonds in emerging markets”, said Chan. The index has 36 per cent exposure to EM countries, compared to just 5.1 per cent in the Barclays Global Aggregate Bond Index.

Hugh Cutler spoke about commodities and the non-correlated performance benefits of investing in this asset class through an ETF wrapper. With Solvency II regulation forcing institutional investors to pay closer attention to risk management and reduce risk in their portfolios, they need returns with reduced volatility said Cutler.

Where LGIM is trying to bring value-add through its commodity ETF products is by selecting the most appropriate indices for its clients. “We select a combination of different indexes to give us the features we want. We do this because our clients simply don’t have the time to do it themselves,” said Cutler.

Over 300 broad commodity indices are analysed to determine which commodity baskets to invest in, with Cutler explaining that LGIM buys the derivative contracts to gain exposure to a specific commodity index via swap arrangements: UCITS-compliant funds cannot invest in physical commodities. Currently, said, Cutler, LGIM was holding 28 per cent in agriculture, 32 per cent in energy, 15.6 per cent in precious metals, 20 per cent in industrial metals and 3.8 per cent in livestock.

Sandy Rattray concluded by talking about smart beta strategies; specifically the Man GLG Europe Plus Source ETF. The Man GLG Europe Plus Index, which the ETF tracks, consists of some 200 stocks. The creation of the ETF product last year came off the back of a strategy that GLG Partners had been running since 2005: namely, to trade on the back of ‘buy’ recommendations from 65 brokers across Europe.

Markets are inefficient. What Man GLG discovered was that once a broker announces a recommendation, the market takes time to digest it. This leads to a sustained period of outperformance lasting up to 60 days, after which it plateaus. If the markets were efficient, said Rattray, such an anomaly wouldn’t exist.

“It’s this anomaly that we are packaging up using the broker recommendations to deliver smart beta,” said Rattray.

The Man GLG Europe Plus fund trades these recommendations early so as to harvest as much of the outperformance as possible. The index on which the ETF fund trades, therefore benefits from this capture of smart beta.

As to why the lag exists, Rattray added: “Institutional active managers take about four weeks to respond to these recommendations. That’s why you get the curve: this is an anomaly, not fundamental alpha.”

The Man GLG Europe Plus Source ETF has approximately USD840 million in AUM and is one of Source’s largest funds.

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