We sat down with Luciano Siracusano, Chief Investment Strategist of WisdomTree, at the Inside ETFs 2017 Conference in Hollywood, Florida. During our conversation, Luciano discussed smart beta, ETF risks and current ETF trends. He also discussed WisdomTree’s family of Quality Dividend Growth ETFs and explained how investors can use dividend-focused strategies to invest in emerging markets.
ETFdb.com: Please tell us about yourself and your role at WisdomTree.
Luciano Siracusano (L.S.): I’m Luciano Siracusano and I am the Chief Investment Strategist at WisdomTree. I also head up our asset allocation team that creates the ETF model portfolios for advisors. We are constantly looking for ways to use ETFs to gain exposure globally across many different asset classes and understand how asset classes behave in concert with each other.
Risks in ETF Investing
ETFdb.com: What would you say are some of the risks associated with ETFs?
L.S.: There’s always the risks of the asset class you’re investing in. I mean, if you’re investing in common stocks, owning them inside of an ETF doesn’t relieve the risk of owning common stocks. What it does do, though, is to remove some of the risks of owning them within an inferior structure. So if you’re thinking about a mutual fund, for example, the mutual fund may not be as tax efficient as the ETF. The mutual fund may have to hold three, five, seven percent cash to meet redemptions. ETFs typically don’t have to do that because they’re traded on an exchange.
Every once in a while though, we have market events and they can be subject to disruption, just like trading stocks on exchanges can be subject to disruptions. But ETFs have been around for 20 years and they’ve proven themselves to be pretty robust.
ETFdb.com: Every investor seems to have his own definition of smart beta. Some call it strategic beta, others call it additional beta. How would you define smart beta?
L.S.: I would say smart beta is the middle ground between traditional passive and traditional active. It’s typically rules-based, index-based products that give people exposure to particular factors. If you have an index-based approach that rebalances and you try to augment that factor in a way that is not market weighted, then you are building a smart beta product.
For a full list of smart beta ETFs, click here.
ETFdb.com: What are some of the benefits and risks associated with smart beta investing?
L.S.: There are two categories of smart beta ETFs: single-factor and multifactor. An example of a benefit for single-factor would be low volatility. A multifactor example would be low volatility dividend.
I think the risk of owning a single-factor is that it may outperform or underperform in any given year. There’s a lot of active risk relative to the benchmark. Any time you narrow your stock selection down to a few dozen stocks, or a few concentrated sectors or countries, you introduce what’s known as active risk, meaning you can diverge greatly from the benchmark in any given year. Sometimes that can disappoint investors. So I would say, unless they have a particular view of which factor they think is likely to outperform during that part of the market cycle – in which case single-factor is perfectly appropriate – they’re probably better off getting a broader exposure that’s tapping into multiple smart beta premiums. That’s what WisdomTree has done in our broad-based indexes.
Read Smart Beta ETFs Can Help You Navigate the Market Cycle to find out about the individual factors within smart beta ETFs.
WisdomTree Quality Dividend Growth ETFs
ETFdb.com: WisdomTree’s Quality Dividend Growth ETFs stress buying quality companies. WisdomTree defines quality using return on equity (ROE) and return on assets (ROA). Can you tell us why WisdomTree decided to hone in on those two metrics and how WisdomTree incorporates both backward-looking and forward-looking metrics to evaluate companies?
L.S.: WisdomTree has been tapping into value, quality and size as premiums for ten years. Over the last three years, we have focused on strategies that focus on quality dividend growth, that screen for companies based on ROE and ROA. The reason for that is there is research that says the greater the operating profitability of the company, the more likely it has been to historically outperform in the market. As a result, we’re trying on equity, but also we’re trying on assets so that companies don’t take on too much leverage to get a higher return on equity. Then, we weight the securities by the dividends they pay, which allows us to rebalance back to relative value. So these are quality strategies that have a relative value balance that helps to control valuation risk. Once you end up with a basket where you have higher quality companies that are dividend payers, you’re set up in many instances to grow dividends faster than the market. We think dividend growth is a source of total return that people should be focused on. It’s a very efficient way to get that exposure.
But I would say if you take a step back more broadly, WisdomTree has been tapping into quality and value for ten years by owning all of the dividend stocks. When you’re not trying to pick which ones are high profitability or not – by just owning all of them – you weight them by dividends. We would view simply weighting by dividends as a way to tap into multiple factors.
Investors think that if you work with dividend stocks you’re only tapping into some kind of high-yielding premium that exists in the market. It is true that this is a value premium. But you’re also tapping into quality, and when we do it with small and mid-cap we’re also tapping into size. I think that’s one of the ways to think about why we at WisdomTree have been able to outperform the major cap-weighted indexes in the small-cap and the mid-cap space[s] in the U.S. going back ten years.
We think that quality dividend growth is a great strategy. It only has a three-year track record, but that’s really designed for folks who want to zero in on the quality part of the market as a factor.
Utilize ETFdb.com’s ETF Screener tool to filter through the entire ETF universe including Dividend ETFs by dozens of criteria such as asset class, sector, region, expense ratio and historical performance.
Navigating Emerging Markets Waters
ETFdb.com: What advice would you give investors and advisors when it comes to navigating the complex and diverse international ETF space?
L.S.: I would say that investors investing in emerging markets expect a very big variation in returns between countries. Some of that variation is a function of what’s going on in the country, sometimes it’s a function of what’s going on with that currency, and sometimes it’s a function of that country benefiting from commodity exports, or from some type of value-added export.
I think investors have two approaches. The first option is for investors to become emerging-market experts who try to navigate countries based on where the countries are in their cycles, and rotate. The second and easier option is to buy emerging markets very broadly. In our opinion, we think the best way to buy emerging markets is probably through a dividend-weighted approach that gets you a very high correlation to the market, but gives you an advantage on starting dividend yield. That’s what we get when we weight it by dividends.
For a full list of WisdomTree ETFs, click here.
Investing in a Rising Interest Rate Environment
ETFdb.com: How do you recommend investors play the U.S. dollar amid this rising interest rate environment?
L.S.: I would say, in the U.S., investors would probably want to tilt towards mid- and small-cap, because the multinationals may have a little bit of a headwind with a stronger dollar. The mid- and small-caps would probably get a bigger benefit from any reduction in corporate tax rates if they have more profit and sales inside the U.S.
Internationally, I think investors need to be aware of countries that either benefit or get hurt by a stronger dollar. The country that benefits the most right now from a stronger dollar is Japan. The reason for that is a stronger dollar typically means a weaker yen, and as the yen weakens it’s good for Japanese stocks, it’s good for their profits and it’s good for their market share. So we think you’d want to have exposure to Japan equities, but in a way that hedges out the impact of the currency. That’s where WisdomTree Japan Hedged Equity Fund (DXJ ) comes into play.
There are four upcoming elections in Europe and any of them could potentially put the euro at risk. We think it’s important to hedge out the euro in Europe, and that’s what we do with WisdomTree Europe Hedged Equity Fund (HEDJ ). So the dollar movement can be more important than any smart beta factor in the short term. It’s not important in the long run because currency tends to net itself out. But in the short run, you can have six-, seven-, eight-year cycles of dollar strength and dollar weakness, where having some way to manage currency risk is going to impact your returns.
WisdomTree’s Robo-Advisor, AdvisorEngine
ETFdb.com: WisdomTree invested $20 million in Advisor Engine, which is formerly Vanare, in November 2016. Can you tell us a little bit about this platform, and how it could potentially change the end-to-end wealth management experience for investors?
L.S.: It’s a digital wealth platform that is really designed for registered investment advisors, for private wealth management. It’s a very robust end-to-end solution that includes technology solutions and ways for advisors and firms to manage their businesses more efficiently. Now, part of that involves what you would call a robo-advisor, where advisors have the opportunity to use ETFs on a platform and create allocations on their own. If they want to use an ETF model that has been created for them, that will also be available. They can then focus on their client relationships and on growing their business. At the same time, they can use WisdomTree under the hood for the asset allocation and for the exposure to our funds. So we think it’s going to be an important distribution channel going forward, particularly for advisors who are looking for a way to upgrade their technology capability for millennials and for a way to manage smaller accounts, so that they don’t have to turn away business just because the asset levels might be below where they usually would have taken a new client.
To learn more about robo-advisors, read ETF Friendly Robo-Advisors. To find out how robo-advisors may impact the future of investing, read How Will Robo-Advisors Impact the Future of Investing.
An Evolving ETF Industry
ETFdb.com: How do you see the ETF industry evolving over the next five years?
L.S.: Firstly, you are generally seeing the majority of ETF inflows go into product prices below 20 basis points (bps). Broadly speaking, fee compression will continue. However, that doesn’t mean that there isn’t a large opportunity for products priced above 20 bps. This is especially the case in niche markets. However, the caveat is that the ETF product must add value. The bottom line is that the competition for low-cost beta will eventually go to zero. You will see expense ratios at one, two or three bps in the near future. When WisdomTree started ten years ago, our test was not to see if we can beat a 3 bps ETF, but rather if we can beat the underlying index, which in reality has no fee associated with it. If you can generate 50, 100 or 200 bps of excess return above the underlying market cap-weighted index, you have a way of adding value for clients.
Secondly, I would say that investors will continue to get more sophisticated about international investing and the role their currency plays. This is a significant growth area in the ETF space over the near future. I think they’ll be more likely to use currency-hedged products going forward, or dynamic currency-hedged products. If they don’t have a view on currency, they would want to let the index make that decision for them.
Thirdly, investors are going to continue to use dividend-paying ETFs to help supplement their income needs in retirement. I don’t think we’re going to ever get away from a world of really low-interest rates. You might see some pickup in yields, but relative to where they’ve been historically. Globally, you might be able to get more income out of the equity market than out of the bond market, particularly government bonds. So we believe there’s going to be continued interest in dividend-weighted ETFs that can get you the total return of the market, or exceed it, and then get you more dividend income in the process.
Finally, as ETF issuers, it’s becoming more competitive for new products. WisdomTree has about 100 ETFs in the marketplace today. The ETF product lineup is evolving and innovation means that there’s always going to be more. A lot of these new products don’t have much in terms of assets or trading volume and they certainly don’t have track records. I would say there is an advantage built in for the top ten ETF managers who have been able to scale and able to get products out there that have hundreds of millions, or billions of assets with a three-, five- or ten-year track record. I would expect the bigger providers to continue to be dominant in the industry and the barriers to entry to become harder and harder for new entrants, including big, big asset management firms that are 10 or 15 years late to the ETF party.
The Bottom Line
WisdomTree suggests that investing in dividend strategies results in investors tapping into value, size and quality premiums. They suggest that it is better to invest entirely in dividend-paying companies and then weight them by dividends. Investors considering dividend-focused strategies should take a look at WisdomTree’s family of Quality Dividend Growth ETFs.
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