US asset management firm Sage Advisory has over USD12 billion under management in its strategic ETF portfolios, 60 per cent for institutional investors, and 40 per cent for retail.
Bob Smith (pictured), Sage President & CIO explains that he and his friend and business partner, Mark MacQueen, started the firm in Austin, Texas some 20 years ago, focusing initially on fixed income asset management focusing on downside protection and bonds and then in 1998, right at the beginning of the rise of the ETF market, Smith started investing in them for some of their institutional clients who were looking for alternatives to equities that fitted with Sage’s top down approach.
The result was a series of hybrid portfolios mixing fixed income and ETFs. Smith says: “By 2005, once the ETF world had matured enough for us to have one or two reasonably large efficient ETFs in each style box we were able to use our Tactical Asset Allocation model that allowed us to over and underweight different parts of the style box in conjunction with our top down view of the global economy.”
In 2007, they built out the core plus fixed income strategies through ETFs. “ETFs replicated what we were doing in our single security type portfolios – it was the same strategy expressed through ETFs,” Smith explains.
In 2008, the firm started a series of target date funds, designed to be at their peak for a target date, such as the date of retirement. “The point was, when we were starting out, our job was to avoid as much of the downside as we could, so we were somewhat constrained in our risk set not taking on a huge amount in terms of volatility,” Smith says.
“The target date strategy garnered a tremendous amount of retirement assets in the US. We were one of the first to express that strategy in an all ETF offering, which was the least expensive route with the highest degree of tracking, liquidity and well described.”
The firm has some USD900 million in those strategies for retirement plans, insurance companies, endowments and foundations.
“What we have done is take the medium of ETFs and use them to create solutions for specific investment needs. We are a bit different from most others out there. We use our analytical services for liability driven analysis and use ETFs in conjunction with our analytics to give our customers a complete investment solution.”
Time has been on their side having been in the ETF business since 1998. “We can look inside the mechanism of the ETF itself and now all the major providers look at us as a beta site,” Smith says. “It’s much as you would look at a stock analyst. We are viewed as being ETF analysts with a rigorous understanding of ETFs and how they operate.”
The firm has now turned its attention to environmental, social and governance (ESG) ETFs. ESG investing jumped 38 per cent in 2015 and Smith says: “We have looked upon the noble efforts by providers to come forth with specific ETFs focused on ESG issues. They were fine but once you started to get into a broad array of them, it was hard to understand what’s more preferential than others.”
The firm notes that ETFs lend themselves well to the screening and factor analyses that underlie the sustainable investment assessment process and has adapted its ETF due diligence process to include an ESG selection process centred upon three primary considerations.
First is developing a deep understanding of the methodology and mechanics of the underlying market index; second, evaluating the structure of the ETF, including the sponsor, its registered form and the effectiveness of the fund's risk management and thirdly, analysing the characteristics of the security itself, including the expense ratio, tracking error, premium/discount NAV trends and secondary market bid/ask spreads.
Smith explains that the firm’s research utilised Sustainalytics and Morningstar data to create a rating system across a wide array of ETFs and index funds to give investors an idea of what is the quality of the ESG orientation in companies within the funds.
“We felt that there is a referee on the field now with this novel and breakthrough metric analysis that allowed you to look at well over a 1000 funds ranked and evaluated in the space. We felt this was an excellent way to accomplish our aims.”
Smith says that the dominant concerns about ESG portfolios is that while investors care about doing good in the world, they also want to do well for themselves, and also there was no uniformity in ESG.
“So what we have done with Sustainalytics and Morningstar data is to create uniformity across the board with the same evaluation systems and Morningstar also put in a credit rating system, a ranking system that allows you to get a handle on how the funds stack up.”
Sage’s approach to investment is undamentally driven with a top down approach and which the firm likes to invest in segments around the world. The firm drove their financial forecasts through the ESG universe, screened to include only the ETFs in the top two quadrants.
“We asked, ‘is there enough there for us to utilise our global economic outlook and come up with the goods?’” Smith says. “So we did that and have gone back over the course of the last year and utilised them within our financial forecasts and found that our ESG portfolio came up with slightly better results than our non ESG portfolio both in terms of growth and lower volatility. We are doing well by the planet and managing ESG needs.”
“We asked would investors be happy with the same return through an ESG portfolio and people said yes, so we hope more and more quality from ESG management skills will bubble up so you see more of the financial outcomes expressed in the value of the stock. This is a breakthrough moment.”
The new ESG product is in its early days for Sage but Smith reports a number of enquiries as people mull over the development and wonder how to utilise it. “This development was internally driven,” he says. “We are fairly committed in Austin, Texas to be environmentally and socially conscious. We have three Millennials on the team and it fits with them and how they see the world. It’s a generational issue.”
Smith concludes: “If my clients can do well for themselves as well as the rest of the world then so be it.”