State Street’s Ross On Gundlach ETF Deal

June 16, 2014

Big-name subadvisors in ETFs make sense, but State Street will only work with a few.

State Street Global Advisors has joined forces with Los Angeles-based DoubleLine Capital to bring to market an actively managed bond fund that will have the expertise of Jeff Gundlach behind it. It goes without saying that Gundlach’s name carries serious weight in the financial world. He headed the multibillion-dollar TCW Total Return Bond Fund until 2009, and earned a reputation for being one of the top managers in the fixed-income space while there. The firm he later founded, DoubleLine, now oversees some $50 billion.

It’s easy to understand why Jim Ross, global head of State Street’s ETF business, would say he’s excited about the relationship with DoubleLine, which he calls “a great partnership.” But Gundlach should be just one of a very small, select group of partners State Street is looking to work with, because when it comes to subadvising ETFs, the second-largest ETF issuer prefers to keep expertise and management in-house. Ross tells us about the deal with Gundlach, and how he sees the competitive challenges, as well as the opportunities in active management in ETFs. State Street has been slowly adding to its lineup of actively managed funds. Do you think people’s pursuit of alpha has helped push asset growth in the predominantly passive ETF market?

Jim Ross: It’s an interesting question. Pursuit of alpha can mean a lot of things, because there’s active and then there’s pursuit of alpha by using passive ETFs. People do that every day. They use ETFs as a building block to get there, and use them for risk allocations and asset allocation strategies as well. I think there's always going to be some type of pursuit of alpha or pursuit of an outcome, depending on what that could be, and that applies to the ETF market—and helps the ETF markets—as well. Is State Street’s partnership with DoubleLine and Jeff Gundlach a strategic move that recognizes the desire for alpha, and the appeal of a big-name manager?

Ross: It’s a move, without question, that we carefully looked at. It’s not our first active subadvisor partner. For example, we did the active subadvisor bank loan product with Blackstone. We also recently launched active equity products with MFS, but obviously Jeffrey and his DoubleLine team are very well known.

What we're trying to do is give existing and potential SPDR shareholders the opportunity to express their views in various markets through both passive and active ways. How does the process of selecting a subadvisor work? Do you reach out to a company like DoubleLine? Did they reach out to you?

Ross: It’s a really good question, and I get that question a lot around here. It can happen in any form. Sometimes it can be as simple as a conversation or somebody saying, “Hey, we considered this, what do you think?” But I’ll say that we have stepped back and looked at a broad strategy around potential subadvised ETFs, and in most cases, it’s been us proactively going out and saying, “Is there interest here?”

But I want to be clear that our goal is not to be a platform for 100 subadvisors, or that we’ll launch anything anyone wants to launch, and you can just use our brand and platform as a distribution platform. It’s really a case where there are certain places and certain types of asset classes that we want to partner on because we think that will bring value to our end client.

We have about five released today—we have Nuveen in the muni space, which is passive; we have a relationship on the mutual fund side, which is active REITs; and we have the three I talked about. And in three to five years, I can see us having more than that, but probably not more than 10.

One of the goals of our strategies is continuing to look for top-notch partners. And the partners we’ve looked for have certain characteristics, like they’ve all been in this business, they’ve managed assets in the past and in most cases, it turns out that we offer them an opportunity for them to enter the ETF space. And, we’re able to bring really high-quality active products to the marketplace. Sometimes we see ETFs change subadvisors after having already been launched. Is that significant? Should a retail ETF investor pay close attention to the subadvisor?

Ross: If you look at it holistically, an investor who’s investing in any fund should absolutely understand how it’s managed and know who the folks involved in it are. And if you’re buying an active fund, you want to understand who’s bringing that active component, and what their history and track record of doing that is.

Even on the passive side, within our business we have one relationship: Nuveen. That relationship was born out of the fact that they had expertise with municipal securities in a way we didn’t have in-house, and we wanted to expand into that area, so it was a win/win. They were at the time exploring whether they should come in to the ETF space, so there were synergies there. In the last two years, SSgA rolled out eight active ETFs, and they’re pretty split in terms of asset classes. Is there a particular segment of the market where active management makes most sense?

Ross: Active management seems most popular in fixed income. But we continue to look at active holistically, and we look for opportunities where we can bring SSGA active capabilities to market, as we did with the original asset allocation funds, and where we can partner. We’re also looking at the next phase of active, which is nontransparent active ETF. The how and when and why on that is a long discussion. I’m not sure how it’s going to unfold. Why do you see nontransparent as the next natural step? It seems a little counterintuitive in a market that’s heralded for transparency.

Ross: It’s a next big step, but there are a lot of steps in between. There’s room for transparent active to grow first. One of the biggest, most challenging questions we get from active teams about ETFs is, “Can we really do this? Daily transparency?” If you’re talking to an active small-cap fundamental manager, 99.9 percent of the time the answer is no. They just don’t think they could.

The passive ETF business has covered the multi-asset class pretty well—I personally think every asset class you can think of has been sliced and diced into different things. The goal of the active ETF space is to tap in to that same landscape in a way that’s not there today. Is it a harder sell, active management versus passive?

Ross: I would say it's a harder sell, because you have to sell the case for the asset class and the case for active. It’s definitely harder. That said, depending on the client and the advisor and what their goals are, they may be very open to that sell.

Today there’s a view that there’s a distinction between ETF financial advisors and advisors using mutual funds—that they’re not one and the same. But we see advisors using ETFs in certain segments, and mutual funds in certain segments. They use other vehicles as well, like hedge funds, single managed accounts.

So there’s room for a lot of different approaches. As an issuer, we’re sitting in front of them with a multi-asset-class discussion with a different assortment of outcomes that they can consider. One could be active fixed, or passive fixed. There’s a different risk dynamic in that. Ultimately, my role is to bring choice to my clients and help them solve their end-client challenges. How they choose to do that is really their decision. How do you see State Street’s competitive challenges right now? Vanguard is closing in, in terms of asset gathering. Does that worry you?

Ross: We always have competitive challenges, but we’re focused on what our strategy is, and we’re expanding. We’ve announced a significant expansion of our intermediary distribution efforts, including hiring the likes of a chief investment strategist, a head of due diligence and a head of practice management.

We’re building a lot of resources around the continuing goal that we have, which is really supporting the intermediary, and helping to grow that part of our business. And we’ve hired a significant amount of external sales resources and internal sales resources to support that.

As far as asset gathering, I think it goes in cycles. Any time the SPDR S&P 500 (SPY | A-100) goes out $20 billion in Q1, everyone looks at it and says, Oh, State Street’s in trouble, and then that tends to moderate and turn around at some point in time. So, we really try and focus more on the long term and less on shorter-term cyclical challenges that we always have because of funds like SPY.


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