By Dani Burger
(Bloomberg) --First JPMorgan Chase & Co. Then Goldman Sachs Group. Now, Wells Fargo & Co. wants to charge into the biggest asset management battleground, exchange-traded funds.
The San Francisco-based bank’s fund unit is considering launching its first ETF within three to six months, company executives said. Following the success of giants that went before, Wells is beefing up its quant credentials as it prepares to compete for a chunk of the $4.1 trillion ETF pie.
Under consideration is a breed of ETF that’s all the rage among the math whizzes who now dominate passive investing. It’s a souped-up version of smart beta known as multifactor, which stuffs two or more investment themes into a single security, for instance value and momentum. Proponents say they’re a way of replicating active managers without their emotions or fees.
“We believe it’s a good time to take a look at things like low volatility, investing factor-based ETFs that are not so dependent on market-weighted stocks,” said Kirk Hartman, global chief investment officer of Wells Fargo Asset Management. “Multifactors, to me, that’s the key to success.”
More multifactor smart beta ETFs have been created this year than any other strategy, data compiled by Bloomberg show.
Wells Fargo fired its first shots in the robots’ direction two months ago with a deal to buy Los Angeles-based quant shop Analytic Investors LLC. Established in 1970, the firm gave Wells Fargo an array of both passive and active multifactor offerings and is now converting those mutual funds into smart beta ETFs.
The bank has some catching up to do. It’s one of the last big fund providers to add a quant arm to its investing force. Goldman Sachs Asset Management, for example, established its quantitative investment strategies team in 1989, getting leg up when it came to products with quant tilts. Wells Fargo will also be up against fund titans like BlackRock Inc. and Invesco Ltd., which have already amassed billions of dollars in assets by selling their clients on smart-beta.
“It’s still early, but this multifactor stuff, especially if it’s packaged to be competitive with commercial indexing, will be really, really big,” said Harin De Silva, president of Analytic Investors. “The thing we’re wrestling with is if it’s sufficiently differentiated because the last thing the world needs now is another ETF.”
To get that differentiation, Wells Fargo wants to bring a new concept to ETFs: factor risk parity. In its usual conception, risk parity is a strategy for partitioning a portfolio’s asset classes according to the size of their price swings. In a typical hedge fund portfolio, for instance, stocks would have a smaller chunk, bonds a bigger one, to balance their impact.
De Silva and other quants think pockets of every investor’s portfolio should be volatility-weighted.
“The biggest thing you can do is give someone this risk parity approach, because then it’s true diversification,” said De Silva. “If you can design a product so it has lower beta and there’s reasonable risk control, you’ll spend less time worrying about what the market is doing.”
Toying With Active
Analytic Investors already uses the structure in its passive strategies. The quants look at the volatility of four or five factors in a portfolio, and once one starts to swing more, its influence is reduced. Combined with its active factor strategies, Analytic oversees about $16.5 billion.
So far, Wells Fargo has launched one factor mutual fund with the help of Analytic. It’s a low-volatility strategy similar to those that dominated the smart beta landscape earlier this year before suffering a deluge of outflows. Since its inception at the end of October, about $26 million has flowed to the product.
Wells Fargo has also toyed with the idea of launching an active ETF. Such securities have been around for over a decade, and, mostly due to high fees, only have about 1 percent of total assets, data compiled by Bloomberg show. The bank is also looking at offering fixed income funds based on factors.
Still, multifactor is at the center of its initial plans.
“We know that institutionally, a lot of the consultants are recommending a core, low volatility, diversified portfolio surrounded by concentrated alpha strategies,” said Hartman.
According to a November study by Invesco PowerShares Capital Management, 71 percent of institutional investors, consultants and private banks expect to increase factor product allocations. It’s a completely different world from when De Silva and his partner Roger Clarke joined Analytic Investors two decades ago.
“At the time, people would look at you like, ‘What are you doing? Aren’t you just buying stocks?”’ De Silva said. “Now when you tell someone you have a quality tilt, they know what it is. It wasn’t until the early 2000s that it actually got popular.”
De Silva prefers the strategies pioneered by Cliff Asness of AQR Capital Management LLC and Dimensional Fund Advisors’ David Booth, who see diversifying across factors as a governing principle of money management. The success of their firms is perhaps the strongest argument in favor of the concept’s viability.
But De Silva is at odds with Asness on one point. The AQR co-founder has long argued that timing the market is difficult, if not impossible, to consistently do well, Asness argued in a April paper. Wells Fargo disagrees. Within the Analytic portfolio are 60 to 70 factors, the influence of which it plans too vary according to preset parameters.
“All of the 70 factors have a timing aspect to them,” said De Silva. “Right now, we’d be increasing our weight in value because value has been doing really well, but it hasn’t done well over the last three years. It looks like it’s the rebound of value.”
For Wells Fargo customers to get a factor-timed product, however, they’ll have to stick with Analytic Investors’ active offerings. It leads to too much turnover in the ETF wrapper. Still, De Silva is convinced that investors will bite at risk parity factor ETFs and launch Wells Fargo into the next leg of growth for the investment industry.