Our experts talk factors and ETFs at recent conferences

July 6, 2018

 
Doug Grim

Doug Grim


Antonio Picca

Antonio Picca


Rich Powers

Rich Powers

Three Vanguard investing experts had the honor of speaking at two recent investment conferences. Rich Powers, head of ETF Product Management, and Doug Grim, a senior investment strategist, were part of panels at the Inside Smart Beta & Active ETFs Summit in New York, while Antonio Picca, head of Factor-Based Strategies, spoke at the Morningstar Investment Conference in Chicago.

We sat down with them to get their thoughts on the events.

Could you share some of the highlights from your sessions?

Rich Powers ("Active management: Why this time is different"): Coming into the conference, I don't think our track record as a successful active manager was well known among the attendees of the Inside Smart Beta & Active ETFs Summit. The presenters at the event were great advocates for our active management capabilities, and that struck a chord with the audience. This conference was a vivid reminder of Vanguard's success as an active manager.

Antonio Picca ("Making sense of the multitude of multifactor ETFs"): For me, the takeaway was that we have to get past the point that we're saying "this is the best approach." Even though we believe our strategy design and implementation increase the probability of investment success, there really isn't a "best" approach. It depends on your goals and your individual situation. We have to work with our investors to make sure they are aware of this.

This topic is also related to another common theme that emerged during the conference: People are still learning how to use factor funds. Use of these funds came up a lot during the press interviews. I was asked to elaborate on use cases and explain how these products can fit in investor portfolios.

What impressions did you get from talking with your fellow presenters and the attendees?

Rich Powers: Skepticism about active overall remains. It stems from the data that say active management success is hard.

We do believe outperformance is obtainable. Three factors most critical to improving the probability of outperformance are low-cost funds, top talent managing the fund, and patience.

Doug Grim ("10 questions in 20 minutes: 10 things you need to know about smart beta but don't"): When evaluating two funds targeting the same factor, or set of factors, one is not necessarily better than the other; they're just different. And those differences can be significant. We have to educate advisors on how to evaluate funds and help them determine whether a particular investment is right for their clients. I can't overemphasize the need to look under the hood of any factor product an advisor is considering and ask questions to understand why it is constructed, rebalanced, and priced in a certain way.

Antonio Picca: Investors have so many choices among factor-based funds. [As of April 30, 2018, Morningstar, Inc., tagged 440 index mutual funds and exchange-traded funds with the multifactor strategic beta attribute.] You still have to do the due diligence because all factor-based funds aren't created equal.

For example, at Vanguard, to achieve our single-factor exposure, we split the starting universe into three groups of stocks that cover the large, medium, and small parts of the market. We score and rank stocks within each of their respective market-cap groupings and then give equal weight to each size group.

An advantage of this construction approach is the greater emphasis on small- and mid-cap stocks, which have historically delivered much larger premiums across all factors.1 This aspect of our methodology helps reduce potential concerns about crowding in the large-cap segment of the market.

Did anything at the conference surprise you?

Rich Powers: There was a notion among the panelists that active fixed income can work and will work in the future. A lot of active managers take meaningful duration risks in their portfolios. So there isn't always a fair comparison there.

There are also a lot of active managers in the marketplace, and many tend to cherry-pick the benchmarks that favor them the most. So advisors really need to look at a fund's performance and make sure it's apples to apples when they compare it with another fund.

Antonio Picca: I was surprised there weren't more questions from the audience on how investors should use factor-based funds. Investors are still skeptical about the ability of factor funds to perform well over a long period of time, but investors are generally comfortable with the factors we are targeting.

These products need to be bought, not sold. When we talk about long-term performance, we mean about 10 to 15 years. Salespeople aren't going to be happy about this, but the reality is, you need to be in for the long term to give yourself the best chance of success.

Doug Grim: One thing that doesn't surprise me is a continued avoidance of the topic of patience with factor-based funds. Most asset managers don't have an incentive to talk about risk, because it doesn't help sell factor-based funds, but if we want advisors to determine which clients these types of funds may be appropriate for, an up-front discussion on patience is critical.

At Vanguard, we have always focused on investor education—telling advisors about the uses and trade-offs of different types of investments so that they can make informed decisions on behalf of their clients. This is no different with factor funds. We explain what factor-based funds can do, how they can and should be used as part of a comprehensive investment strategy, and how advisors can coach their clients through the inevitable bumps in the performance road along the way.

A year from now, what do you expect people will talk about at the 2019 Morningstar and Inside Smart Beta conferences?

Rich Powers: I think the Inside Smart Beta & Active ETFs Summit will be more about investor outcomes. I see managers looking at investor experiences more.

Doug Grim: I think that up until now, these conferences have focused on educating advisors about what factors are and how they can perform (and rightfully so). But now we can afford to take it further and talk about the practical applications of how advisors implement these concepts and key considerations for thorough factor product due diligence.

Antonio Picca: I completely agree with Doug. I would like to see more discussion around the practical implementation of how factor funds can be used. I've seen a lot of research telling people how factors perform, but I haven't seen much information on how to use them. I really think the attendees could benefit from that type of discussion. We'll keep our focus on educating the marketplace on how these products can be a valuable tool in investors' portfolios.

1 Eugene F. Fama and Kenneth R. French, 2016. Choosing Factors. Accessed June 15, 2018, at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2834871.

Important information:

  • Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.
  • All investing is subject to risk, including the possible loss of the money you invest.
  • Factor funds are subject to investment style risk, which is chance that returns from the types of stocks in which the fund invests will trail returns from the stock market. Factor funds are subject to manager risk, which is the chance that poor security selection will cause the fund to underperform relevant benchmarks or other funds with a similar investment objective.

 

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