Pitching A New Star Stock Picker ETF

February 13, 2015

ETF.com: It sounds like a rules-based index in some sense. I know it's not; it's an actively managed security, and you're making the decisions along the way on the basis of these quantitative models that you just alluded to, right?


Reese: Well, there are rules, but the rules are more heuristics. These are interpretations of how legendary investors said they went about picking stocks and what the considerations were. So, there's a judgment being made by each of 10 different models whether a stock is even worthwhile holding.


There are 10 that go into the ETF. Each model selects 10 stocks. So we took very-high-performing, but less correlated models that make up the ETF. But rather than concentrate on just one year, I like to use the longest term available.


ETF.com: And in the aggregate, when you add the 10 models, they're equally weighted in the portfolio, right, for each of the models?


Reese: Correct.


ETF.com: What about portfolio and tax consequences? Is this more of a tactical kind of strategy that will shift with some frequency, or, more of a strategic approach where there's a real serious buy-and-hold?


Reese: First of all, the strategy itself is for the long term and remains consistent. I found one of the best ways of outperforming the stock market over very long periods of time is by staying consistent in strategy, not looking for the hottest strategy in the last 12 months.


Our portfolios will have about 100-125 percent turnover during the year as we keep in the highest-rated stocks and remove lower-rated stocks.


ETF.com: And is that turnover consequential in any sense from a taxation perspective for a nonretirement account?


Reese: It is not consequential from a tax perspective in the ETF. That's part of the magic of the ETF.


I pitch it as for somebody who is committed to the stock market for the long term and wants to have the best chance of outperforming a market index such as the S&P 500 by a compounded few percent per year.


ETF.com: And what’s the overall pitch?


Reese: I anticipate over a longer period of time—let's say a five- or 10-year period of time—a compounded 3-4 percentage points per year incremental return. Not every year, but over a longer holding period. Four of the models that were actually used in the selection of the ETF have almost doubled the S&P 500 performance since 2003.


ETF.com: Now, GURU costs 75 basis points and IBLN is 65, which puts you in a similar ballpark. But how might you respond to objections that this strategy looks pricey relative to what the ETF market can serve up these days? Even these so-called smart-beta strategies—with value screens, quality screens, quality mix screens that can outperform the broad market—have expense ratios that are relatively modest. I'm thinking like one of those Rob Arnott screens on a PowerShares fund are about 40 basis points or so. How do you respond?


Reese: I hope I've done a good job of explaining how it is different from the Research Associates smart-beta funds. And certainly I hope I've shown how it's different from an index fund. So I feel we're right in the median price range for a fund that is actively managed and shows the potential for substantial outperformance.


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