USAA On Using & Creating ETFs

September 14, 2017

Lance HumphreyUSAA is a massive institutional ETF investor, with $8 billion in ETF assets spread across the firm’s investment management and insurance business sides. The firm is also about to become an ETF issuer, with plans to bring to market six ETFs before the end of this year, four of them smart-beta equity ETFs with a focus on value and momentum, as well as an intermediate-term bond and a short-term bond active ETF.

With a membership exceeding 12 million people, and a military community in this country comprising 22 million veterans and their families, USAA says its potential footprint both as an asset manager and ETF sponsor could extend to more than 60 million Americans.

The firm, which has also been growing in the intermediary space, working with advisors and RIAs in recent years, is banking on its strong name brand, long-standing reputation, and massive potential market to drive ETF usage across the board.

Lance Humphrey, portfolio manager for USAA’s global multi-asset portfolios, gives us the latest rundown on what USAA has been doing with and for ETFs. USAA Investment Management tends to own more core beta ETFs like the iShares iBoxx $ High Yield Corporate Bond ETF (HYG), and the insurance side tends to own more “smart beta” funds—like the Goldman Sachs ActiveBeta U.S. Large Cap Equity ETF (GSLC). Tell me about that distinction.

Humphrey: We use ETFs across several of our asset allocation mutual funds in the investment management side, which is the team I'm part of. Our team has about $5.5 billion today in ETFs, and a third of that is in smart-beta assets, so the majority of that smart-beta asset is in the insurance portfolio.

We use ETFs for four primary purposes in our asset allocation; the first being tactical asset allocation; the second being risk management; we also do some cash equitization; and, lastly, strategic asset allocation.

That first one is where we're the most active in ETFs. If we want to shift a portfolio—say we became more bullish on emerging markets and less bullish on U.S.—it's easy to sell the iShares International Select Dividend ETF (IDV) and buy the iShares Core MSCI Emerging Markets ETF (IEMG). It's cheap, liquid and effective.

In our mutual funds, we tend to do more of that tactical management, so that's why you end up seeing a lot of the IVV types. I wouldn't say we have intentionally put it out that way; it's just that we're doing more tactical asset allocation in those asset allocation mutual funds, in which case we use some of the bigger, broad, passive ETFs.

In the insurance portfolio, we hold a lot of multifactor smart beta. We've got some single-factor smart beta too, but we don't trade it as much, which is why we feel comfortable using those particular ETFs. Do you ever compare the returns of the investment-side approach to the insurance side?

Humphrey: We don't look at that, because we're trying to accomplish different things. But at the end of the day, the portfolios tend to actually be similar. They’re just constructed a little differently. The return streams end up being relatively similar. What’s the driving goal of the investment side versus the driving goal of the insurance side?

Humphrey: We want to outperform our benchmark over time in both cases. We want to provide a better risk-adjusted return over time. What makes each of those portfolios different is they have different benchmarks or objectives.

For instance, if we take our Cornerstone Moderate Fund—where the benchmark is 50% stocks, 50% bonds—our objective is to outperform that particular benchmark, as opposed to the portfolio that we manage in our insurance account, which is 100% equity. What I will say is the components of the 100% equity are a lot like the 50% allocation to equity that are in the other fund. On the tactical side, it seems equity, bonds and gold are all up this year—that hasn’t happened often. How are you navigating that?

Humphrey: We've actually been less hands-on than normal because of that. There hasn't been a lot of dispersion amongst asset classes. So some of our tactical views this year are that we really like emerging markets over the U.S., for instance—for many reasons, such as attractive valuation and improving fundamentals. There's also positive price momentum. That’s what we’re focusing on from a tactical perspective.

But, again, I’d say we've had fewer changes this year than we would in a normal year, because assets are all moving together.


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