We recently had the chance to speak with William Belden, head of ETF business development for Guggenheim Investments. We discussed Guggenheim’s overall ETF strategy and its newly launched Guggenheim Large Cap Optimized Diversification ETF (OPD ).
ETFdb.com (ETFdb): Guggenheim has a long track record with strategic-beta strategies, and today manages about $27.5 billion in ETF AUM. What is Guggenheim’s overall strategy in the ETF space?
William Belden (W.B.): Guggenheim is the eighth-largest domestic ETF sponsor in the U.S. We have 75 different ETFs covering a range of solutions, beginning with the first strategic-beta ETF that we launched back in 2003; the S&P 500 Equal Weight ETF (RSP ) remains our largest with more than $9 billion in AUM
Extending into fixed income, we cover both the passive side of fixed income and the active side. The passive side is represented by our BulletShares suite of defined-maturity ETFs, which has approximately $7 billion in AUM. The active side is represented by another recent product launch, which builds upon the heritage and legacy of Guggenheim. So back in February we launched (GTO ), which is the Guggenheim Total Return Bond ETF, to deliver the biggest and oldest fixed-income strategy managed at Guggenheim in an ETF wrapper, which we’re very excited about.
ETFdb: Guggenheim recently launched the Guggenheim Large Cap Optimized Diversification ETF (OPD), a strategic-beta ETF that tracks the Wilshire Large Cap Optimized Diversification Index. Can you tell us more about this ETF’s overall strategy, and how it can improve diversification?
W.B.: I mentioned that back in 2003, RSP was our first strategic-beta ETF. Over time, Guggenheim has established a strong reputation as an innovator in the ETF space. And this latest offering, I think, builds upon that legacy. The launch of Guggenheim’s Large Cap Optimized Diversification ETF, which tracks that Wilshire Index you noted, really seeks to deliver the benefits of diversification. It really improved risk-adjusted returns by taking diversification and applying the methodology that amplifies the benefit of what it could bring to a client’s portfolio. That’s really all about risk-adjusted return.
What happens is that Wilshire has established a methodology by which they take their parent index, which is their large-cap index, and their large-cap equity index, and they identify those holdings with the most attractive correlation characteristics. It really builds upon the thesis that if you want to improve, or beat an index, you have to have a different composition than that index.
And so it goes through those 750 names that are in the parent, the large-cap index, and identifies those that are additive to a correlation characteristic, which in low correlation, obviously speaks to better or improved diversification. The names continue to be added to the portfolio to the extent that they add to the diversification benefit of that portfolio.
ETFdb: When you talk about low correlation, are you talking about moving towards zero/neutral correlation or more of an inverse correlation?
W.B.: To the extent that you’re moving directionally towards zero, you become added to the index. So even if it’s just a marginally better diversification benefit, relative to not adding that name, then yes. Now, the portfolio is a subset of the index, so it’s not going to be a zero correlation relative to the parent index, of course. But if you find that the marginal benefit of adding that name versus not adding that name results in you adding that name, then of course you’re improving upon the diversification benefit. And that’s the byproduct of having a lower correlation.
The concept of portfolio diversification is built upon the combination of assets that aren’t highly correlated. So really, if you build upon that and subject that portfolio not just necessarily to correlation characteristics but also to constraints to stock and sector risk, then you’re going to end up with a portfolio that’s about 100 to 120 names. Your result is basically a market level of risk; market being defined as the parent index’s risk, with the opportunity to provide upside total return, and hence a better risk-adjusted return profile than the parent index.
ETFdb: Currently, there are many strategic-beta ETFs on the market, especially in the last few years. How does OPD differ from other strategic-beta ETFs?
W.B.: I think it really is focusing on the diversification benefit. At the end of the day, what strategic-beta consists of is trying to improve upon a parent index, or some comparable index of some sort. If you’ve got the standard that you’re trying to improve upon, what can you actually deliver that defines and presents that improvement? That definition usually is measured by its risk-adjusted returns.
So you’ll find some strategic-beta indexes that talk about a better performance, but better performance can be measured by lower risk. It can be measured by better total, or higher total return. At the end of the day, those are combined into what investors should be focused on, which is their risk-adjusted returns.
There are different ways in which ETF sponsors are going about delivering upon that. In our case with OPD, we’re saying that this is not a low-volatility strategy, and it’s not a strategy that’s designed to maximize total return without any recognition or consideration for risk. It’s really designed to amplify the benefits of diversification, hence the name, and provide those returns to you. It provides a position for you to potentially realize the outside total returns with that consideration for risk that is addressed by optimizing the diversification.
ETFdb: What type of investor should hold OPD?
W.B.: We think that this is a core position in an equity allocation within a client portfolio. And if you’re able to deliver upon a large-cap equity mandate with the opportunity to provide higher risk-adjusted returns than investing in a parent index, then we believe that that’s any investor who has domestic equity exposure.
I think that somebody who is comfortable with the market level of risk can make the decision regarding what percentage of their portfolio should be allocated to large-cap domestic equities. This would fit within that bucket.
The Bottom Line
The first quarter of 2016 was a very good reminder of why an investment plan is crucial, especially in this very uncertain/volatile environment. Overall, having more options for diversification beyond the classical approaches is key to navigating this environment. The strategic-beta ETF space continues to increase with more options for investors. Currently, Guggenheim offers a new product for those investors looking for diversification.
