ETFs For Retirement Protection

When it comes to your nest egg, there are different guardrails you can use to protect your hard-earned money. 

Blue Sky Asset Management is known for its focus on risk management solutions targeted at clients who are at or near retirement. The firm has put its expertise in drawdown protection in a family of ETFs offered under the brand QuantX.

They include:

• QuantX Risk Managed Multi-Asset Total Return ETF (QXTR)
• QuantX Risk Managed Growth ETF (QXGG)
• QuantX Dynamic Beta US Equity ETF (XUSA)
• QuantX Risk Managed Multi-Asset Income ETF (QXMI)
• QuantX Risk Managed Real Return ETF (QXRR)

Blue Sky’s Keys Tinney, managing partner, and David Varadi, head of research, say the motivation behind their products was simple: Retirement investors can’t afford drawdowns. Losses at that stage in the game come with serious consequences—having to spend less in retirement, having to work longer or having to go back to work entirely to make up for the loss. Tinney and Varadi tell us how they work.

Keys Tinney

Managing Partner

Blue Sky

Dave Varadi

Head of Research

Blue Sky

ETF.com: What's unique about the way you approach risk in a portfolio?

Keys Tinney: Blue Sky rose out of another RIA that served clients that were at or around retirement. We were the portfolio arm of that business. Those clients can't afford to have a substantial drawdown—and that’s where our thinking comes from.

We wanted to offer some sort of systematic way of managing risk in the portfolio that went beyond typical diversification. We found that using different concepts like momentum, trend-following, volatility as an indication of where risk is in the markets, etc., were all great for that goal.

We believe in the prototypical diversification, but we’re adding an overlay that says, “If the waters get too choppy, we’re going to de-risk the portfolio. And when the waters smooth out, we’ll put more chips back on the table.”

ETF.com: You have four risk-managed ETFs. Are they four different guardrails that belong in the same portfolio? Or do you pick and choose? Let’s talk application.

Tinney: We look at these as colors on a color palette. We want to give an advisor who has global equity exposure in, say, SPY [SPDR S&P 500 ETF Trust] and EFA [iShares MSCI EAFE ETF], the same exposure, but with guardrails on the downside. QXGG, the growth portfolio, effectively gives global equity exposure with guardrails on it.

You could do the same thing with multi-asset income, or with the total return, which is more the go-anywhere portfolio. And the real return gives you commodity exposure. You can also blend them. If you have SPY, EFA, EEM [iShares MSCI Emerging Markets ETF], you can add one of our ETFs for protection, depending on the environment.

ETF.com: Two of these ETFs, QXTR and QXRR, are absolute-return strategies. What’s the key difference between what they’re trying to do?

David Varadi: Basically, the real-return ETF QXRR represents more of an inflation hedge. It’s essentially a portfolio that has diverse exposure to assets that would respond positively to inflationary movements and be correlated to the commodity index. QXRR would be exclusively what we would consider to be real-return assets or real assets.

The total return ETF, QXTR, is essentially something that can go anywhere. It can hold commodities; it can hold equities; it can focus on fixed income.

ETF.com: The ETF QXGG can have the whole portfolio moved into cash or cash equivalents at some point. How likely is that to happen? Would an investor be willing to pay 1.22% in expense ratio to hold 100% cash?

Varadi: We like to think of things in terms of offense/defense. When we’re heavily defensive—where we might have, say, 60 to 80% or more in cash or fixed income—it’s generally a situation where our indicators are saying the trend is down, and that as a result, the expected return is probably negative.

Typically we’re going to be in cash during periods like 2008, when you might lose a substantial amount of money. So the 1% that you're paying—or the cash that's not invested—is earning a substantially superior return relative to trying to stay invested.

We look at it as a safety asset. It’s pivoting into short-term cash or cash equivalents to avoid substantial drawdown. It certainly doesn’t happen very often.

ETF.com: How does an investor know if they’re overexposed to risk or underexposed?

Tinney: The short answer is maybe a different question, which is, if I'm about to retire or retired, how am I going to be able to earn the rate of return that my nest egg needs? And not just day one, but on year 30?

When you're looking at that kind of math equation, you have to factor in that if you’re in a traditional portfolio, your returns are projected to be low; fixed income, same. We’re at 2% on the 10-year [Treasury]. And most likely interest rates are going to rise, which means bond funds will lose money.

What’s the solution for the investor who needs that 5-7% rate of return on the portfolio to accomplish their goals? Where are they going to get it?

The only place they're going to get any kind of return is going to be on the equity side of the markets, because we don’t have the 30-year tail wind in bonds anymore.

So they have to increase equity exposure, which increases risk, which they don’t want to have more of. The right recipe comes with equity exposure without all the risk. That’s what’s driven our risk-managed ETFs.

Our strategies are dynamic, so they can make adjustments as needed. But finding the right mix is very much a challenge right now. We haven’t seen interest rates in this kind of systemic easing. We’re in uncharted territory.

Advisors are staring into some seriously challenging head winds, and many are using other types of investments, whether they’re alternative mutual funds or pure asset-class exposure via ETFs to try and diversify. We’re offering a systematic way to help get out of the way of the falling knife.

ETF.com: What are the biggest risks facing investors today, and how would you tackle them?

Varadi: There are three primary risks. There's the risk of both inflation or deflation—and that’s the function of our current monetary policy, fiscal policy environment, and the fact that we’re eight years into a bull market. Both can be significant.

We have the risk of a large recession or credit crisis like in 2008. We also have the prospect of rates going substantially higher. Right now you can't really earn money on bonds.

If you have a dynamic approach that’s risk managed, it allows you to be able to shuffle the portfolio toward the general macroeconomic trends that happen to be in favor at the time and avoid many of those risks.

If it’s highly inflationary, we have a strategic diversification: We recommend holding all the different funds together in combination.

For example, the total-return ETF is a way to help bias the portfolio toward the prevailing macroeconomic trend. We’ll tend to invest more in fixed income if it tends to be more of a deflationary environment; more to real assets if it tends to be an inflationary environment; more into fixed income if it happens to be a recession or a credit crisis; and more into equities if it happens to be an expansionary period.

If you have a strategic passive portfolio, it’s like taking your car, plotting a route, putting it on autopilot and hoping there are no bends in the road, no issues.

But we believe in the next 10 years there will be a lot of bends in the road. If you don’t prepare for them, you could have adverse outcomes, and the average investor can't afford to have that.

ETF.com: Your ETF, XUSA, has a link to the options market and a different name than your risk-managed ETF lineup. Where does this fund fit in?

Varadi: This is our all-equity, always-in-the-market fund. We consider it a smart-beta ETF. But it’s unique because it’s the only fund that uses options market data to select stocks. XUSA is designed to stand on its own, and, secondly, to enhance QXGG, our growth fund.

The purpose of XUSA is to give you asymmetric returns, or the ability to generate substantial upside relative to downside, but to always be fully invested in equities; in other words, give you a little bit of extra juice while still maintaining a strong risk-reward.

XUSA uses forward-looking options market data to identify stocks that have the most favorable upside volatility relative to downside volatility. In a bull market, you want to be more in higher-beta names. In a bear market, you want to be in more consumer-staples or lower-beta names. We use portfolio beta as a means of managing risk, and getting more of an asymmetric return.

ETF.com: What are the main risks of owning these ETFs? When will they not work well?

Varadi: The potential risk with the risk-managed funds is that there's no prevailing macroeconomic trend. During a period where there’s a lot of news headlines and a lot of noise—but very few trends to latch onto—that may be a period where you have lower relative performance.

Tinney: I would add that the risk-managed funds won’t protect you from a flash crash, from something that happens over one, two days. We’re trying to protect from extended periods of drawdown. We’re not moving day-to-day to do any of this stuff.

Once we see a trend of market decline or markets rising, we make adjustments. We evaluate portfolios and risk-managed funds daily. It doesn’t mean we’re making adjustments daily.

ETF.com: Your firm is the biggest holder of these funds, right? Do these ETFs solve an internal client problem, or do you see them as something the ETF market was lacking?

Tinney: We’ve gotten great feedback from advisors, but it’s taken time to educate people about them. It’s not “Schwab has a new 0.03% S&P 500 ETF, so I can save some money”; these are alternative investments packaged in ETFs. We’ve been talking with advisors, and we’re pushing more with our sales organization.

We intend to add more colors to the color palette, because there's a gap in the market when it comes to this type of solution. There're a few firms that have trend-based approaches, but they're not trying to get you out of the way of the falling knife; they're trying to get more return. We believe in diversification.

ETF.com: There's a big focus on cost among ETF investors. QuantX ETFs aren’t cheap. Is the idea here that portfolio insurance doesn’t come cheap?

Tinney: We looked for the least expensive way to offer the protection we’re trying to provide. If we packaged it in an alternative mutual fund category, our expenses are below market. We’re alternatives. We’re not trying to compete against SPY. That’s not our market.

I’d love to have $1 trillion under management, but that’s not what we’re going for. We’re trying to find a place as an alternative, yet transparent and highly tax-efficient manager of capital versus the alternatives in the mutual fund route, where costs aren’t as much an issue, and transparency isn’t there. After factoring fees in, investors are still light years better off than if we did what we’re doing in any other wrappers.

Contact Cinthia Murphy at [email protected]