ETF Strategy Summit
October 15-16, 2018 | Hyatt Regency | Dallas, TX
Rick Lake – Lake Partners
The Evolution of Alternative ETFs
Rick Lake is the Co-Founder & Co-Chairman at Lake Partners. He oversees the firm’s research on mutual funds and ETFs that utilize alternative strategies, and helps direct the company’s team effort in asset allocation, investment research, and multi-manager investment programs. We recently sat down with Rick, who will be speaking at our ETF Strategy Summit (Oct. 15 – 16 – Dallas), as he walked us through the different alternative strategies available.
ETF Strategy Summit: What explains the growing interest in alternative ETFs?
Rick Lake: Rising rates and rising volatility present new challenges for portfolio construction, risk management, and diversification. Major forces are reversing the market dynamics of the recent past:
- The Fed is raising rates
- Global central banks have begun to tighten and to reduce balance sheets
- U.S. debt issuance is rising
- Inflation is accelerating
Stocks and bonds are becoming correlated—which undermines traditional “60/40” asset allocation. Select liquid alternative strategies may serve as tools to help reduce risk and improve portfolio diversification. These potentially diversifying strategies are now available as lower-cost, user-friendly ETFs, many of which are also tax-efficient.
ETF Strategy Summit: How has the universe of alternative ETFs evolved?
Rick Lake: The universe of alternative ETFs includes a broad range of alternative strategies and assets. Long/short equity, option writing, non-traditional bonds, arbitrage, global macro, and managed futures are alternative strategies now available via ETFs. Commodities, currencies, and volatility are the primary alternative assets available as ETFs. Alternative ETFs have come a long way from leveraged and short index funds. As innovation continues and investor demand grows, the universe of alternative ETFs should expand, and provide additional sources of return and more tools for risk management.
ETF Strategy Summit: How are alternative ETFs different from alternative mutual funds or hedge funds?
Rick Lake: Alternative ETFs represent the latest trend in the “Democratization of Risk Management.” Their costs to investors can be significantly lower than alternative mutual funds or hedge funds. We have constructed diversified portfolios of alternative ETFs where the underlying funds have average expense ratios of approximately 55 to 60 bps—significantly lower than the “2% and 20% plus expenses” structure of the classic hedge fund or the average weighted expense ratio of approximately 1.9% for the largest Morningstar Categories of alternative mutual funds. The trade-off is the narrower range of alternative strategies currently available in the ETF format.
Another difference is the type of strategies in each structure. The investor protection requirements of the ’40 Act limit the use of leverage and illiquid securities in registered, daily liquid funds. Also, alternative ETFs tend to focus on rules-based approaches, although index-oriented and active approaches are also available. Over time, investors and managers will seek to match the strategy with the most appropriate delivery vehicle.
ETF Strategy Summit: How much should advisors allocate to alternatives or alternative ETFs?
Rick Lake: Speaking with advisors around the country, many have concluded that a minimum 10% allocation is required to have an impact. Depending on the investment experience of clients and the size of the client portfolios, we have seen advisors implement allocations to alternatives of 20%, 30% or more. The allocations are based on risk/return targets, and how alternatives are utilized to complement traditional assets. A diversified approach to implementation is preferred, due to the idiosyncratic nature of the underlying alternative funds and strategies. Many advisors will tap multialternative funds or SMAs, seeking specialist managers to help oversee the process.
ETF Strategy Summit: What should advisors and investors be mindful of in alternative ETFs?
Rick Lake: Speculators trading VIX products during the market break of February rediscovered that less volatile approaches may be prudent. Careful analysis of alternative investments is required to understand the risks and the potential nature of the return stream. Enlisting outside experts dedicated to the sector may be worthwhile. Using such a resource may help enhance results or provide advisors with more time to focus on client service.
ETF Strategy Summit: Thanks Rick. We look forward to hearing more of your thoughts at the ETF Strategy Summit October 15 – 16 in Dallas.