Brad Roth is CIO and founder at THOR Financial Technologies. He has dedicated his career to leveraging technologies to remove human emotion and bias from the investment process, including overseeing a number of model portfolios as well as THLV, a low-volatility ETF that recently became one of the first ETFs to have a physical presence on the NYSE floor.
Russ Alan Prince: How has technology changed the low-volatility industry?
Brad Roth: It’s our view that technology is changing the investment industry as a whole. We are going to see a rise in ETFs that use technology, AI, and machine learning to not only build portfolios but to make investment decisions and optimize proper allocations. We wanted to implement some of these processes in the low-volatility space because we felt that low volatility wasn't delivering the type of drawdown protection clients actually want in these investments.
AI-driven investment engines are telling funds when to move into defensive positions and de-risk portfolios. The rise of AI in asset management puts the spotlight on a lot of the legacy names that claim to have low-volatility products, but in reality, they simply underperform during typical bull markets and underperform even worse during periods of extreme market stress. A low-volatility strategy should experience index-like returns with much less standard deviation and downside capture. This is the guiding principle of what low-volatility truly stands for. Technology is changing this for the better with the industry now having access to low-volatility products that practice what they preach.
Prince: What should advisors know about drawdown protection?
Roth: Advisors need to realize that “low-volatility" doesn't necessarily mean lower drawdowns. When markets sell-off, we tend to see selling occur quicker and across the board. This was evident in 2020 when at the bottom of the S&P 500, low-volatility giants like USMV and SPLV drew down capital in excess of the S&P 500.
These funds cannot get defensive by their design. To give a true low volatility experience there needs to be drawdown protection in the design, such as getting defensive and raising cash in periods of high market stress. When you think about it, many low-volatility funds are financial oxymorons. You can throw a dart and there’s a good chance they don’t actually reduce exposure to volatility or have any drawdown protection. There needs to be an industry-wide effort to look at new ways to reduce volatility—to incorporate the drawdown protection that traditional diversification techniques fail to offer.
Prince: How do advisors benefit from a fund having a designated market maker?
Roth: First and foremost, it ensures liquidity during the opening and closing auctions; the first and last 15 minutes of the trading day. Unfortunately over the years, ETF issuers informed advisors on the best and worst times to make any trades, generally being cautious around the opening and closing auctions. This is because we would see vast dislocations between the price and the
ETF issuers were informing advisors on the best times to trade/not trade, being cautious around open/close, etc. This is because we would see vast dislocations between the price and the net asset value during these times. Having a designated market maker removes that frustrating element for issuers and shareholders. The designated market maker system drastically improves spreads by keeping funds aligned with the net asset value, with liquidity, and keeping tighter and more liquid opening and closing auctions.
Prince: How are advisors using ETFs in their model portfolio construction for clients?
Roth: There is certainly no shortage of ETFs available with nearly 9,000 unique funds at this point. There’s been a quiet trend bubbling up in recent years where many model portfolios have brought their strategies to the public markets, giving advisors the ability to create highly diversified portfolios at a better cost to the client while having liquidity intraday to make any necessary changes. The massive boon we experienced in ETF launches over the last decade brought on a shift where advisors now primarily only use ETFs in their portfolio construction. This is a drastic change from prior decades where we typically saw single stock and mutual fund holdings.
Many of the advisors we speak with are seeking ETF strategies that rely on non-traditional sciences and technology to manage their assets; something that truly sets them apart from what the advisor down the street is using or what many of today’s retail investors are accessing on their own. Because of this, we’re seeing a number of really unique portfolios constructed only with ETFs.
Russ Alan Prince is the executive director of Private Wealth magazine and chief content officer for High-Net-Worth Genius. He consults with family offices, the wealthy, fast-tracking entrepreneurs and select professionals.