Passives – A methodical Approach
Given the innovation in passive investing, it pays to look closely at the diﬀerent instruments and strategies available in each asset class before taking the plunge
We use passive instruments to implement our tactical asset allocations. However, there are many questions to be considered. Following a top-down approach, we frst defne how much we allocate
to diﬀerent asset classes. In each asset class, we defne in which area, sector or theme we would like to invest.
FIXED INCOME FOCUS
Focusing on bonds, where our main expertise lies, we invest directly in carefully selected individual bonds with ratings between double B and single A. However, we do opportunistically invest in ETFs. For instance, if US
Treasury yields rise sharply, we might consider tactically buying a US Treasury tracking ETF with a long duration to bet that the yield will fall again (reverting to the mean). It’s also possible to buy short bond ETFs to proft from
rising yields. Considering this, the performance of such instruments is path dependent – it could happen that yields rise, benchmarks are down, but the short ETF doesnot reﬂect this properly. Therefore, we do not use short bond ETFs.
On the equity side, frstly we choose the most interesting regions and then styles (momentum, value or dividend). For instance, in the US, we mainly buy long-only ETFs or index funds (S&P 500, Nasdaq 100 or Russell 2000), as
most active managers underperform in this region. On the other hand, in emerging market equities, we only allocate to active managers. For instance, we have recently invested in Vietnam by reducing our China A-shares. Both
investments were done through an active fund.
From time to time, we consider an allocation to styles and themes. Smart beta products are a play that we may consider in this universe, for instance, by deploying money to momentum or low beta strategies. Whichever
approach we choose to take, we implement sector ideas with index trackers. As an illustration: So far, the best way to approximate the global tech sector has been to buy a Nasdaq 100 ETF, because global active technology funds
have had difculties outperforming this narrow US index.
WHAT’S THE ALTERNATIVE?
In the alternatives space, we have come across strategies claiming to ‘replicate’ indices quantitatively, and that they can not only match underlying hedge fund indices but also deliver alpha by investing into liquid futures and plain
vanilla bonds, equities and currencies. The fees are at low levels, comparable to ETFs, but with hindsight most of these products have vanished due to poor results, underperforming the already poor hedge fund indices.
Similar things can be said about ETFs tracking private equity indices. We therefore would only consider active managers who we have met and where we have done thorough due diligence. However, the illiquid space is
very crowded, and ultra-high-net-worth individuals and institutional investors are deploying heavily into this area. We therefore think that future returns will be lower compared with historical returns.
Published by Andreas Bickel, June 2019, Citywire Switzerland