How adaptive risk allocation works
September 17, 2019
*Morningstar data from 07/01/2018 through 6/30/2019. Columbia Diversified Fixed Income Allocation ETF was benchmarked against its peer group of US Multisector Bond open-ended and exchange traded funds. The number of investments ranked during this time-period, in this category, was 354, of which DIAL was the top performer based on absolute return.
Marc Zeitoun: With $150 billions of net new assets falling into ETFs, there's no question that clients are exhibiting a preference for passive solutions. I think what's really interesting is when you break that apart, you see there are two types of passive solutions. There's ETFs that track a major market index, which we might call a benchmark beta, and then there are ETFs that encapsulate a strategic beta idea.
Marc Zeitoun: A strategic beta is something that was developed with an investment objective in mind, whether it's income or muted volatility, and 25 cents of every dollar is going into strategic beta. We see that as a persistent flow. This is not a fad. This is staying. What's important, now, is to understand how these things work. And immediately, the mind goes to, "Well, how complicated can strategic beta really be?"
Marc Zeitoun: At Columbia Threadneedle, we would ask investors and advisors to take a step back and go the other way: Do you know what's in the benchmark? Do you understand how the major market indices are created? And some people think that it's not important to understand that. We actually think that it is, and especially with fixed-income, where 60% of the flows today are going into the passive world, understanding how indices like the Barclays Agg are constructed makes all the difference in the world. With 60% of the flows going into fixed-income, it becomes even more important to understand the recipe behind these major market indices.
Marc Zeitoun: One of the things that we have found, is that there is a false understanding of what the Barclay Agg is. Despite the word "aggregate," it is not an aggregate of the entire fixed-income world. Actually, it represents a small sliver of the true fixed-income opportunity when you look at it globally. And so, understanding the rule set behind these major market indices, is critical: not only from an exposure perspective, but from a construction perspective.
Marc Zeitoun: Think about how bond indices are typically created. We use the word "market cap weighted," but in fixed-income, that means debt-valuated, when in actuality it means most of your assets are being allocated to the largest indebted entities. That somehow doesn't ring right when you think about where you're going to allocate your assets, so we think that fixed-income has a natural place in a passive setting. We just think that clients are expecting a little bit more thought than the randomness that's found in a major market index.
Marc Zeitoun: Equally as interesting to us about whether people understand the rules or not is, are investors actually taking the time to understand who's managing the money? We take it for granted in a mutual fund, or in an actively managed SMA, that the portfolio manager makes all the difference in the world. Yet, with an ETF, many advisors don't really know who's managing the fund or care to understand who's managing the fund.
Marc Zeitoun: We at Columbia Threadneedle Investments take a completely different approach to that. We don't start with a benchmark and tweak it, and re-weight it, to deliver a strategic beta solution. We start with our strongest competencies. We ask the four- and five-star Morningstar rated PM to be involved in a rules creation, and then we ask her or him to manage the portfolio. We went into the universe and we looked at all the prospectuses of all these strategic beta funds, whether they were fixed-income or U.S. equity.
Marc Zeitoun: And we found, decidedly, that those fixed-income strategic beta solutions that have an active portfolio manager in the prospectus, have consistently out-performed those that do not, on a one-year, three-year, five-year basis. Then to make sure that this wasn't just a fixed-income anomaly, we did the same thing with U.S. equity, and again, we found that the universe of strategic beta ETFs with an active portfolio manager, out-performed that universe that didn't.
Marc Zeitoun: And so, we believe that is just an expression of the involvement of the active manager, whether it be the rule set of the index that it's tracking, or just the daily oversight. But we conclude that investment experience matters, and we're proud of it at Columbia Threadneedle Investments.
Marc Zeitoun: A perfect example of what I'm talking about is DIAL. DIAL, which stands for Diversified Fixed-Income Allocation ETF, was launched in October of 2017. We worked with our multi-sector team at Columbia Threadneedle to develop this. They are managing the fund, and it is the number one multi-sector fund across all ETFs and mutual funds over the last 12 months. The reason it's out-performing is because of its diversification and individual rule-sets. So, it allocates fixed-income across six different sectors, ranging from U.S. dollar denominated emerging market debt, to quality high-yield.
Marc Zeitoun: And those rules, whether that the high-yield is limited to quality, or that the emerging market debt is limited to U.S. dollar denominations, all of that comes from the years of experience in managing assets in those sectors. We know, for example, that certain parts of the high-yield market are more volatile than others, and that for this solution, our clients would likely prefer something that is more risk-adjusted than something that is not.
Marc Zeitoun: And so, all of these rules together work very well as a multi-sector plan should, and that's what's contributing to DIAL's success. With so much attention being spent on fixed-income, it's important to have the right solution at hand. We think that DIAL fits that bill. It is an intelligent, timely, and relevant solution; and more importantly, it's easy to implement and actionable.
Marc Zeitoun: We're excited about what's ahead. More and more people are adopting passive solutions as part of their investment allocations, and we think it's great. We just want people to take the time to understand the rules beneath those solutions, and to consider that who's managing the money actually makes a difference.