USAA On Using & Creating ETFs

Asset manager and soon-to-be ETF issuer discusses how it chooses ETFs, how it uses them and where opportunities lie.

Reviewed by: Cinthia Murphy
Edited by: Cinthia Murphy

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. How often do you evaluate new ETFs?

Humphrey: Being heavily involved in ETFs, we're always looking at new products that are coming to market. We have some analytic tools that we've built in-house to look at various measures.

Something I like to do is look at what my total cost of ownership is based on a projected time horizon. That's going to take into account things like projected bid/ask spreads, commissions we would have to pay, trading friction costs.

I always have a good idea of ETFs out there that meet our necessary thresholds. As new ETFs come to market, we review them very carefully.

The tactical passive side doesn't change as much because there's not a lot of change in leadership among the big liquid ETFs.

But when it comes to the strategic beta or factor-based investing, there are new and innovative products coming out all the time. Oftentimes we're willing to invest relatively early in those particular ETFs if they meet some of the standards we require in order to invest. What pockets of the market do you like right now?

Humphrey: We really like emerging market value. It's been cheap for a long time, but we look at relative valuation. It could be cheap for a long time, and it could be cheap for a reason. So what we like to do is see that coupled with improving fundamentals, improving price momentum.

Over the last four or five years, value within emerging markets has severely underperformed U.S. large-cap stocks. But if you look over the last year, there’s been quite an improvement. There's a long way to go.

Specifically, we really like the Schwab Fundamental Emerging Markets Large Co. Index ETF (FNDE). The PowerShares FTSE RAFI Emerging Markets Portfolio (PXH) is another one.

On the margin, we’d been overweight high yield. Spreads had become very wide, and yields were 9-10%. But those spreads have tightened a lot in the past several months, and now they're below average levels. The yields are relatively low. So we've been trimming a lot of that tactical high-yield exposure. We've probably cut our position in half over the last six months. Did you replace that with anything else for yield?

Humphrey: Not necessarily for yield, because that was more of a relative value trade we put on for absolute returns. But it does so happen that we've increased the credit quality of the portfolio.

As we've been selling high yield, we've been buying things such as Treasuries, even long-term Treasuries, even though the yields are low there. That's really a function of derisking the bond part of the portfolio, primarily to help offset our adding of EM value, which is a very volatile asset class. We're basically “barbelling” the portfolio.

I'm excited about that positioning because if markets continue to do well, the emerging market value space will continue to do really well.

On the fixed-income side, having Treasuries for liquidity is great. Again, ETFs have allowed us to effectively do these trades. Are there ETF tools you wish existed?

Humphrey: There are times I think there's some niche-y areas of the market that people may want. You have a couple of floating-rate bond ETFs today, but that's certainly not a saturated space.

I think BlackRock had launched a few rating-specific ETFs, and there are times that would have been interesting to us. You can have mortgages, you can have Treasuries, you can have corporates, but what if I want BBB corporates? What if I want single A’s?

Those are some examples. I do think there's going to continue to be a lot of product development in the fixed-income space. USAA is one of the biggest clients of Goldman Sachs’ ETF operations. You’re also working to launch your own ETFs. Are you looking to create ETFs that would replace things you're currently using, or is this about another vehicle your clients are looking for?

Humphrey: I think more the latter. USAA has been in the asset management business since the 1970s. We offer individual mutual funds, brokerage accounts, managed accounts, a robo advisory service. We've continued to evolve our product set and to meet our member needs. We’re trying to provide core competitive products that our members can use to build globally diversified portfolios.

And there's clearly demand from our membership for ETFs. Even financial advisors that we do business with are increasing their demand for ETFs. It's just a natural extension of our existing product set to offer these ETFs.

We've been one of the more innovative users of smart-beta ETFs, so it makes sense for us to offer products to our members that pass along some of the things we've been doing in our portfolios to allow our members to have access to that same type of thing. Would you invest in your own ETFs?
It's certainly a possibility. In our funds, we're going to look at what we believe is the best ETF for the particular problem we're trying to solve. Our ETFs will be evaluated as any other ETF would be.

Contact Cinthia Murphy at [email protected]


Cinthia Murphy is head of digital experience, advocating for the user in all that does. She previously served as managing editor and writer for, specializing in ETF content and multimedia. Cinthia’s experience includes time at Dow Jones and former BridgeNews, covering commodity futures markets in Chicago and Brazil equities in Sao Paulo. She has a bachelor’s degree in journalism from the University of Missouri-Columbia.