ETF Portfolios: An Option To Endowments

November 18, 2014

Any investor can achieve the risk/return profile of sophisticated endowment funds with liquid, transparent and diversified ETFs.

This article is part of a regular series of thought leadership pieces from some of the more influential ETF asset managers in the money management industry. Today's article is by Hafeez Esmail, San Francisco-based Main Management’s director of compliance.

The average wealthy investor simply can’t invest the way large college endowments can, in part because they don’t have access to the same vehicles. With a long-term time frame, endowments can afford to hold illiquid hard assets for extended periods of time.

Moreover, the elite institutions typically have access to the best and brightest managers, including those running hedge funds and private equity portfolios. But is it possible to replicate the risk/return profile of these sophisticated endowments using an all-ETF approach?

Let’s examine the performance of some of America’s best-known universities over the past seven years. This period covers the financial crisis of 2007-2009 and thus an important time frame to include in the analysis.

Let’s compare their results with an ETF asset management firm that is accessible to wealthy clients with more than $1 million in liquid net worth. You’ll excuse me for choosing two ETF portfolios designed and run by our firm, Main Management. But the reasons are more than self-serving.

Consider Main’s Buy Write strategy, a hedged approach to equity markets that incorporates option writing as a key component for reducing volatility; and the Main Active Sector Rotation strategy, a U.S. Equity Sector Rotation strategy based on fundamental analysis. Both strategies are liquid, transparent and diversified, and both happen to be very tax aware.


Can The Endowment Return Profile Be Replicated?

In many ways, the chart, on its face, speaks volumes.

Main’s BuyWrite Hedged Equity strategy performed ahead of roughly half of the Ivy-caliber schools. The BuyWrite strategy has the long-term risk/return characteristics of a 60 percent equity/40 percent fixed-income portfolio.

Although a direct comparison to an all-equity approach, like Main’s Active Sector Rotation Strategy, is probably unfair, it’s clear that adding more equity to the mix would enhance the merits of a transparent ETF approach.

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How About Performance Through The Great Recession?


Remarkably, not a single endowment outperformed Main Sector Rotation Strategy, an all-equity approach, for the 2009 fiscal year, and several of them had a larger drawdown than the overall equity market as measured by the S&P 500.

Perhaps not quite as surprising, Main’s Buy Write Hedged Equity approach was up to thousands of basis points better than the Ivy-caliber endowments, including 1,440 basis points better than the Harvard endowment.

To be perfectly clear, the 2009 fiscal year for most endowments ended June 30, 2009.

That means the losses you’re looking at above reflect the effects of many, if not all, of the gut-wrenching moments that sparked the market meltdown. The events I’m talking about include:

  • The failures of Fannie Mae and Freddie Mac
  • The massive government rescue of AIG
  • Bank of America’s forced takeover of Merrill Lynch
  • And—not least—the Lehman Brothers bankruptcy

But that’s not all: The 2009 fiscal year also includes the entire second quarter of 2009 and the final three weeks of March of that year. In other words, those 15 weeks all followed the market low of March 9, 2009.

Asset Classes Become Closely Correlated During A Drawdown

During a downturn, practically all risk assets move in the same direction, albeit to slightly varying degrees.

So how does one diversify assets during a significant downturn? Essentially, there are three main assets classes—stocks, bonds and cash. Correctly allocating among these categories will have a far greater impact on portfolio returns than the remote timber property that was supposed to be the perfect hard-asset hedge.

In addition, as a risk management tool, I would add call options to the equation. During significant market pullbacks, volatility typically rises. As volatility rises, so do option premiums. Accordingly, this provides an effective hedge, albeit a partial hedge, to your underlying holdings.

Liquid, Transparent, Diversified ETF Portfolios Deliver

The conclusion is almost inescapable: A skilled, experienced ETF asset manager, using liquid, diversified products and, potentially, incorporating option strategies can deliver the risk/return profile of sophisticated university endowments. For the wealthy investor trying to replicate an endowment approach, a managed ETF portfolio looks to be the right path.

A pioneer in managing all-ETF portfolios, Main Management LLC is committed to delivering transparent, cost-efficient and customized investment solutions. By combining asset allocation insights with smart implementation vehicles, Main Management offers a unique approach that translates into distinct advantages for our clients, including diversification, cost efficiency, tax awareness and transparency.



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