Kranefuss: 2 Crises Face Financial Advisors

June 01, 2016 On your site, you talk about “dynamically managed” global ETF portfolios. What exactly is this concept of dynamic management? Is it like hedge- fund-type investing?

Kranefuss: Hedge funds are in crisis, too. They're failing to deliver, because many of them are just repackaging security selections in one way or another. What people lack is good asset allocation.

By being dynamic, we're trying to explain it as neither a long-term, somewhat static strategic approach nor a short-term tactical one. We look at a broad array of markets and their historical and current relationships. We then try to get a very broad portfolio that has the opportunity to pick up things that might improve or gain value while at the same time being able to exit.

At times, the trading will be more active because there's more shifting going on, and one's trying to be more defensive and get out of potential harm's way. And other times, it can be more static. It's really driven by what's happening in markets.

The world has often defined itself in asset allocation. I used to run the asset allocation and target-date retirement funds businesses at BGI. I would get caught up in this false dichotomy of strategic, which gets you back to your 60/40—which I don't think makes sense to talk about anymore—or tactical, where you're always trying to trade your way to something.

We’re trying to get a broad set of exposure return drivers—which you can do with ETFs—and then shift exposures so as to minimize downside risk while trying to maximize upside capture, and doing it in a way that is premised on really understanding the underlying ETFs, not only the economics of the portfolio.

I'll give you an example. There's a lot of interest in currency-hedged foreign investment. If you're buying a currency-hedged ETF for Japan, you're taking a position on currency expectations. Everyone thinks of it as reducing risk. But you might not be. It may be that you've actually inadvertently increased risk and decreased return. Your overall risk/return has gotten worse.

You have to think about where else might you have exposure to currency that may pop up somewhere else—in parts of the U.S. economy or sectors that do a great deal of business with Japan, for example.

These are the kinds of things that get passed over a lot. People tend to think of a portfolio not as the integrated whole of all the elements and how they interact, but rather as a piece of this, a piece of that. And unfortunately, people can end up paying more for positions that are offsetting one another. Is 55 Capital going to pitch a flagship series of strategies, or will you customize portfolios that solve the equation on a client-to-client basis?

Kranefuss: It depends on the size of the client. Initially we're targeting RIAs who already outsource to traditional fund companies or strategists. We'll have sort of flagship strategies that will begin with entry-level ones into some larger ones.

Entry level might be five or six ETFs for someone who's trying to invest maybe a trust fund they set up for their grandchildren, e.g., they have $20,000. We don't have to balance that many positions in that.

It’ll go up to our more dynamic strategies, where we're moving a lot, not only changing weights of asset-class exposure but also exposures within assets classes—what parts of those markets look good. In those, we might take 40 or 50 positions. Should RIAs look at dynamically managed portfolios as the new core?

Kranefuss: Yes, I'd say it's the core. Every client's different, because there are real estate holdings and illiquid stock and the like. But if somebody has a totally liquid portfolio, you might put 50% into this strategy. You don’t want to run the risk of combining too many ETFs and approaches and getting mud. They used to call that, in the institutional market, the “closet indexing.” You hire 50 active managers, and when you throw them all together, on average, they own the index.

Although everyone is taught portfolio theory, it's one of those things that's hard for most people to get their arms around. You have to have a way of monitoring and assessing if two managers are just canceling each other out, and you’re paying a lot for that. You need a more holistic view in light of the current environment, and to understand what you're investing in.


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