Risk is the yin and yang of investing––you can’t make a lot of money without it, but too much of it in the wrong places can sink your portfolio. That thought permeates the philosophy at Lattice Strategies, a money manager with roughly $1.7 billion in institutional and retail assets under management that recently launched four exchange-traded funds based on the concept of risk management.
Three of the funds––the Lattice Emerging Markets Strategy ETF (ROAM), Lattice Developed Markets (ex-US) Strategy ETF (RODM) and Lattice US Equity Strategy ETF (ROUS)––launched in late February. The Lattice Global Small Cap Strategy ETF (ROGS) began trading in late March.
All four ETFs are based on indexes that were created by Lattice, and are calculated and maintained by Solactive AG.
Based in San Francisco, Lattice’s calling card is what it calls a risk-first approach to investment management. “We start with the view that risk allocation––how you configure allocations within and across asset classes––is the primary driver of long-term capital growth,” says Ted Lucas, managing partner and investment committee chairman at Lattice.
He calls it the “upside-down philosophy” on risk and return, which he says differs from approaches where risk allocation is the consequence––rather than the driving force––of portfolio composition.
Lucas says when most people think about risk and risk allocation, they interpret that to mean risk reduction. “To generate return in what probably will be a low-return environment across asset classes going forward, you have to take risk,” Lucas explains. “What we’re trying to do is provide our advisory clients with better risk allocation that gives them a better probability of success in generating growth for their clients.”
Lattice is no stranger to ETFs, at least from a user perspective. The company rolled out its first multi-asset class, or liquid endowment strategy in 2007, principally with family offices. The firm’s model included a meaningful slice of liquid alternative investments, such as ETFs, to create a portfolio with greater liquidity, flexibility and cost efficiencies than a typical endowment strategy.
Since then, Lattice has expanded its client base beyond family offices and built a suite of liquid endowment strategies and single-asset class strategies. And now it has expanded its repertoire with its four new ETFs.
“The effort to create our own ETFs came from the view that while the use of traditional passive, cap-weighted ETFs has served us well, we thought we could enhance our multi-asset solutions by taking a fresh look at how to allocate risk within each of these building blocks,” Lucas says. “And we felt our risk-first approach could provide a tool set to the wider advisory universe.”
Each Lattice strategy index tries to address identified risks within each asset class, such as country, company, and currency concentrations, valuation considerations, and other unmanaged risk factors. Lattice’s risk-optimized approach is about the deliberate and intentional re-allocation of specific risks.
With the Lattice Emerging Markets Strategy ETF, for example, the index methodology establishes risk-balanced country baskets reflecting each country’s general economic footprint, and tilts its allocations within and across countries by emphasizing companies with favorable combinations of relative valuation, momentum, and quality characteristics. That produces a fund with less reliance on larger, export-driven emerging economies, and more exposure to smaller and more locally driven emerging economies.
“We’re not eliminating those [large, export-driven] countries, we’re just saying there are two dozen countries to allocate across and we want to balance risk so we have better exposure to consumers in local markets than you’d get with cap-weighted indexes,” Lucas says.
The Lattice emerging-markets ETF carries a low price-to-earnings ratio of about 12.5, and has relatively balanced exposures among the top 10 country holdings ranging from Taiwan (about 9 percent) to Chile (nearly 6 percent). China and South Korea––two large export-driven economies––comprise roughly 8 percent and 7 percent of the fund’s country allocation.
Darek Wojnar, managing director and head of single-asset strategies at Lattice, says the company’s ETFs are rules-based passive products, but each fund’s underlying index is purposefully built with specific criteria in mind that reallocate capital away from traditional market-cap weighting.
“From that perspective it’s a deliberate active allocation of the risk capital across their respective universe,” says Wojnar, who prior to joining Lattice was head of U.S. products for iShares, the ETF division of asset manager BlackRock.