"Using index strategies is useful to garner returns from asset classes like large-cap growth stocks, where alpha generation is extremely difficult," says Frank G. DeMaio, CFA and CFP of Sterling Financial, a financial planning group in Concord, N.H. "The actively managed SMAs are probably better used in less efficient areas of the market such as small-cap and value strategies where alpha can be gleaned more readily."
Indexing, Hedge Fund Replication, And The World Of ETFs
Despite the application of the firm's models to high-net-worth individuals and families, one of the firm's goals is to provide institutional-caliber investment strategies to a broader set of investors.
"Rules-Based Alpha is where we really bridge the gap between traditional active and passive management and pull institutional investment strategies into a construct suitable for a broad set of investors," says Patti. "We applied our knowledge initially to equity products based on what we learned with the Fortune 500, using fundamental factors to create more value. Whether it's diversification, lower volatility, or better performance, again, it's all about taking investing to the next level."
ETFs are the perfect investment vehicle to accommodate this broader appeal. They are structures that both advisors and their clients easily understand, Patti explains. Since they are a universal tool for which customization is not as important, ETFs create turnkey methods of employing sophisticated strategies in complex investment vehicles such as commodities, emerging markets, and foreign countries. The ETF structure makes these strategies accessible to investors with smaller assets who normally would not have sufficient asset levels to attract managers who employ such strategies.
Another focus of product development at Index IQ was in hedge fund replication. "We wanted to replicate the performance characteristics of hedge funds and what they're providing today-what the broader universe of hedge funds is providing-and offer it under 100 basis points with full liquidity," says Patti. "We felt there might be a lot of value there." The firm developed six underlying strategies including long/short, market neutral and global macro and rolled them into a composite. This was then placed into an ETF so that investors at any level could access an investment that provided alternative beta, low correlation and low volatility.
The three strategies-Rules-based alpha, rotation and hedge fund replication-have all been made available through SMA, ETF and mutual fund investment structures.
The Jury is Still Out
Surz has doubts that the strategies are anything new. "I see a lot of form, but not substance," he notes.
Todd Battaglia, president of Meg Green & Associates in Miami, says, "I understand a lot of what they're trying to do with the indexes, and it looks like there's a Stern School relationship, so it seems very cerebral at some level-very heavily researched. To me, it feels more like a unit investment trust (UIT), and I don't find that much that's unique about it. I see a lot of these academics' ideas on paper and back tested. And it sounds pretty good! There have been a couple of instances where academics have been able to run portfolios and build wealth. But I think the jury's still out-I'm just not sure how successful they've been."
"Often, academia fails to take into consideration the different needs of individual investors," says Lisa Gray. "Their institutional models don't deal with the different types of tax exposures, the different types of ownership structures, asset locations, and the liquidity and life-event-driven needs with which even multi-million-dollar investors contend." DeMaio offers, "I think these strategies are useful for folks of varying net worth. There are merits to combining qualitative and quantitative strategies in a portfolio-primarily greater diversification and greater risk management."