Oppenheimer Funds, the traditional active manager, made its first foray into exchange traded funds with the acquisition of RevenueShares in 2015, a small “smart beta” management firm in Philadelphia. Since then, Oppenheimer has taken a “buy and build” approach to its ETF business, launching three new revenue-related products of its own, as well as six single-factor strategies and two multi-factor strategies. The firm’s ETF business has grown to $2.5 billion in assets.
Mo Haghbin, head of Product, Beta Solutions, joined Oppenheimer Funds last January after spending 10 years at BlackRock. David Mazza, head of ETF investment strategy, joined a year ago after 12 years at State Street Global Advisors. Their task is to translate some of the firm’s active investment strategies into rules-based investment strategies. Wealthmanagement.com spoke to them about the appeal of multi-factor funds, the recent problems with volatility funds, and how passive and active investment strategies can co-exist.
WealthManagement.com: You all have launched some multi-factor ETFs. What’s the appeal to the investor?
Mo Haghbin: The big investment thesis around multi-factor is diversification. If you think about the first single factor strategies that came out; you’re talking about 2002 to 2003 of the S&P partnership with PowerShares. So, low-volatility products came out. Value, momentum products came out. And on a standalone basis, all of those factors have merit. Where I think they fall down a little bit is they tend to behave very cyclically. What I mean by that is every one of them will have its day. But in shorter periods of time, they can have pretty significant drawdowns versus the market. They tend to run high tracking error. Multi-factor is great because what it does is it diversifies across two or more factors, where their excess returns are uncorrelated. Momentum, for example, and value are great diversifiers. When you bring them into the portfolio together, you access two different sources of risk and return coming from that risk premia.
Dave Mazza: If I want to make a decision that I want to make my portfolio tilted toward more inexpensively priced stocks, a value factor ETF can be great for that. Or, if I’m using active managers that have exposure to momentum or growth, but I want to complement that with something else to not disrupt what they may be doing, I can use a single factor ETF. When you’re combining factors together into a single product on the multi-factor side, that’s when it gets a little bit closer to being a total solution, a core holding if you will, as opposed to more of a tool than a single factor could be.
WM: What are the factors you’ve identified for your product?
MH: We’ve identified six: quality, which is a balance sheet quality factor; value, which is trying to capture richness versus cheapness—in this case cheapness; momentum, which is price momentum; size, which is effectively smaller companies; yield, which is effectively higher yielding stocks versus lower yielding stocks; and low volatility, which is essentially price volatility.
WM: With the recent correction, there were some issues with volatility funds. What went wrong?
MH: The first high-level problem is a classification issue. An ETF right now means a lot of things to a lot of different people. Some people have now said certain things are ETPs, certain things are ETFs, certain things are ETNs. But at the end of the day, a levered and inverse product is more different than a fully funded ETF. And sometimes what happens is the market looks at a particular problem and expands that to include a whole industry.
My view personally on that issue was, you had a lot of products that were structured to deliver something that wasn’t necessarily explained to the end investor in terms of what they’re delivering. If you’re short volatility with three times leverage that resets daily, when volatility picks up that day you could have a very, very negative outcome.
I will say that ETNs and levered and inverse ETFs or ETPs should be treated the same way as options and futures are treated. If I want to go buy a future or if I want to go buy options on my account, I need a different approval requirement, and I also need to be a sophisticated investor that has a certain amount of assets and signs various disclosures around buying those products. Similarly, with levered and inverse ETFs and ETNs, I think there needs to be separate approval and some oversight on how people are using it.
WM: There are a lot of assets going into these multi-factor funds. Could that lead to increased volatility?
MH: I don’t think we’re there yet. If I look at the aggregate assets in mutual funds and ETFs and smart beta ETFs and then go into factor-based ETFs, it’s still a pretty small portion of the overall market. We’re at $20 trillion in assets in equities, smart beta is about $700 billion of that. About $220 billion of it is in factor-based products.
Where I would start to get concerned is if everyone defined factors the same way and you saw a significant concentration in all of these factor-based approaches, then you could see something that would be troublesome. But what we find is that there are a lot of differing views in how to capture the factors, and there are a lot of different views around how to build portfolios—whether that be single stock, an ETF, a mutual fund, a separate account. That actually is very healthy for the ecosystem, because you’ve got buyers and sellers interacting in the market, and everyone’s not on one side of the trade.
There’s a lot of attention around active versus passive. They need to coexist, and there needs to be a balance between both type of strategies. Active managers, if you think about it in a theoretical sense, are setting prices. They’re actually going in and doing the bottom-up research; they’re looking at balance sheets; they’re having conversations with management teams. And passive managers are essentially relying on that work to make sure they’re paying the appropriate price. The active managers doing the price discovery; the passive manager is using that price discovery to get invested. If that balance doesn’t exist, I actually think both suffer.
WM: What are some of the most difficult elements to investing in multi-factor strategies for ETF providers, for advisors, for clients?
DM: There has been product proliferation, especially on the multi-factor side. So investors have struggled to understand and peel back the onion on all the various strategies, because there’ve been more tools offered to them.
MH: The biggest challenge is understanding the space in between. If you’re an advisor, it’s really simple to say I own the S&P 500. I don’t have to do any due diligence on that. I got the cheapest product. I don’t have to explain that decision. Similarly, if I go to a credible and very prominent active manager—the bond king of the day—and I hire that person, I don’t have to explain that either. If you’re in the space in between, now you really need to do due diligence.
WM: What are some of the newest developments with ETFs?
MH: Although assets are growing at this rapid pace, volumes aren’t necessarily growing at the same pace. What this tells me is ETFs aren’t being traded as much as they used to. They’re being bought and held. So they’re being used as longer-term investment vehicles, where in the past, there was this stigma around ETFs that these were trading vehicles. Now people are adopting the wrapper because it really is a better way to access the market. We know all the benefits around transparency and tax efficiency; that’s really coming online in a bigger way now.
What I think is happening is there’s going to be these second waves of winners, where active managers are now taking a lot of their insights and packaging them up in rules-based ways and delivering them to clients to be a complement and also an alternative to pure passive. Where State Street, BlackRock and Vanguard have really excelled is the simplest of simple for very cheap. Where I think active managers have the edge is taking what they’ve been doing for decades and decades and packaging it at a reasonable price point and deliver it in a wrapper that everybody is adopting and accepting as the better way to invest. I do expect to see some market share erosion at the top of the house into some of these more boutique or specialized asset managers that have capabilities.