ETF.com: Let's talk about the ValueShares U.S. Quantitative Value ETF (QVAL | C-58). Would you say that the ETF is meant for the long-term investor who believes markets are inefficient?
Gray: Yes. The base requirement is that you have to believe in the value anomaly. You have to believe it is driven by some element of market inefficiency, which is a combination of bad market behavior on behalf of participants, and also an inability for a large pool of capital to exploit it. If you believe in that, if you believe in value investing, we think that that vehicle is great for a longtime horizon investor. You need time to be successful.
If you're day-trading the ETF, you're going to get killed on taxes and fees. Also, you’re almost inevitably going to buy it when it's doing well, and you're going to be getting out at the wrong time. It’s a buy-and-hold, Warren Buffett-style, long-term, compound, tax-deferred, don't-worry-about-the short-term-vol-relative-to-an-index ETF, and you would buy it if you believe in the value anomaly.
ETF.com: How does QVAL compare with a passive competitor such as the iShares Core U.S. Value ETF (IUSV | A-93)? IUSV has almost $1 billion in assets and costs 9 basis points, when QVAL costs 79 basis points. Is the active management worth the cost difference?
Gray: Our answer to that is, it depends on what you believe as far as what is actually active and what it isn't. When you look at pretty much all iShares products, they're built for capacity and scale, and they're essentially closet indexing products. That's great, but what you're really buying when you engineer out the exposures is 95 percent S&P exposure, and then maybe 5 percent of actual value investing anomaly.
What we tell people is that these closet-indexing strategies are not capturing the actual value anomaly, which is the spread that has historically been identified of around 5-6 percent between expensive stocks and cheap stocks. If you look at what exposure you're buying through iShares or Vanguard, or any of these ETFs, you're not exploiting the anomaly. You're essentially going to track the S&P 500 with a little noise.
That’s fine, because it's tax efficient; it's cheap. And I love passive investing more than anyone—I think it's a great thing, on average. However, for people who want to bet on actual active value exposure, you need to either do it via a concentrated mutual fund, which is going to be twice as expensive and tax inefficient, or you have to move into the private space and deal with hedge fund guys.
So yes, we do think it's worth it. But it really boils down to whether or not you believe in active investing.