We sat down with Martin Kremenstein, Head of ETFs at Nuveen Investments during the Morningstar ETF Conference last month. We discussed Nuveen’s overall strategy, municipal bonds and Nuveen’s new aggregate bond ETF. Kremenstein also shared his opinions on some of the challenges and opportunities of competing in such a crowded and evolving ETF market.
ETFdb.com: Please tell us about yourself as well as about the career trajectory that led you to becoming Head of ETFs at Nuveen.
Martin Kremenstein (M.K.): I started working in finance in London back in 1998 straight out of school, and did a variety of jobs working for Chase Manhattan JPMorgan London. I entered the ETF space in August of 2006 when I joined Deutsche Bank. At the time, Deutsche Bank had one ETF, PowerShares DB Commodity Index Tracking Fund (DBC ), and were about to launch their second ETF, PowerShares DB G10 Currency Harvest Fund (DBV ). We built out our business. Asset flows in 2009 were phenomenal; we started the year at $4.5 billion and ended the year at $13.5 billion. We became the number six ETF issuer in the U.S. by assets at that point. We realized that for the business to continue to grow and thrive, we needed to pivot away from being just a commodity provider. We polished our offerings by acquiring PowerShares (which was sold to Invesco in 2014.) Furthermore, we decided to build international equity products that would allow investors to protect against the strength of the rising dollar. I helped launch those products and the U.S. X-trackers business as CEO of that business.
A little over a year ago, I decided to look at other career options and was interested in going to a buy-side solution-based institution. I joined Nuveen in October 2015.
ETFdb: Nuveen has strong exposure in the municipal bond market. What is Nuveen’s overall strategy in the ETF space?
M.K.: Nuveen definitely has a strong muni shop, as that’s how we made our name originally. I think it’s important to consider Nuveen in the context that it is now – a division of TIAA Global Asset Management (TGAM). TGAM is an incredibly strong fixed income shop that runs assets for the overall insurance company. Our strategy is to tap into the strengths of TGAM in a way that’s additive to the lineup. The question we should really dig into is, “Where is TGAM strong?”, rather than “Where is Nuveen strong?”
ETFdb: One of the primary reasons why investors invest in municipal bond ETFs would be for tax exemptions at the state and federal levels. Other than tax, what are the additional reasons why investors should look at municipal bonds? What would be a good piece of advice that you would give investors for due diligence related to munis?
M.K.: Obviously, the main reason would be for tax advantages. I think investors are looking for a stable investment; many investors equate muni bonds as safe-haven investments. I think when you are looking at munis, you need diversification in your fixed income. It’s a great way to diversify without taking on added risk.
I think munis is a very specialized market and, therefore, you need to do your due diligence on the manager. This applies to ETFs and index products. You need a good manager to execute against a benchmark; execution in fixed income is a big deal, especially in the less liquid parts of fixed income. Munis can become illiquid from time to time. I think having a skilled experienced manager with strength and depth is very important.
ETFdb: Last year Nuveen revealed plans on converting a couple of commodity closed-end funds into ETFs – the Nuveen Diversified Commodity Fund and Nuveen Long/Short Commodity Total Return Fund. What was the rationale for bringing these ETFs to market? Do you think every investor should have some exposure to commodities in their portfolio?
M.K.: I am a proponent of commodities in your portfolio. The biggest reasons for having them in your portfolio are for their diversification benefits and to hedge against expected inflation.
In terms of the products you mentioned, they were trading at steep discounts. We wanted to find a way to close the gap i.e. discount, while allowing investors to stay invested and giving them a better outcome. For investors who wanted to get out, they can redeem their shares now. This was a way to satisfy both parties – people that wanted in and that wanted out. We felt this was the best way to do it.
ETFdb: You recently had a new ETF that was launched – the NuShares Enhanced Yield US Aggregate Bond ETF (NUAG). What inspired the vision for this particular ETF? What is the proposed strategy, and what type of securities will the ETF hold?
M.K.: It is an aggregate universe we started with; it’s the BofA Merrill Lynch Global Broad Bond Market Index. It is targeted toward the U.S. investor and denominated in U.S. dollars.
We divided the aggregate universe into 38 sectors by maturity and by underlying asset class, like Treasuries, corporates, securitized debt and then, within those maturities and asset classes, by credit rating. We are breaking the link between issuance weighting and the weighting in your portfolio. Rather than weighting by issuance, we are weighting by yield and overweighting high-yielding sectors. We have a strong quantitative fixed-income team at TGAM. We used our models to isolate a risk factor, similar to factor investing, but at a fixed-income level. Historically, the majority of returns have come from yield, so why not weight by that? Which is what the NUAG ETF does; it divides the aggregate universe into buckets, and builds an optimized portfolio in which we are high yielding without taking on any extra duration. We haven’t downgraded the credit spectrum by much, and have kept our key rate risk the same. It is this risk-managed framework that allows you to boost your core fixed-income holding.
ETFdb: What are some of the challenges and opportunities of competing in such a crowded ETF market? How do you see the ETF industry evolving over the next five years?
M.K.: I think the biggest challenge is getting space to be sold and to be heard. There are so many active managers doing multi-factor ETFs. For us, we want to zig where others zag. We are looking for less served areas of the market. If I am the 20th multi-factor option out there, I am not really offering investors anything new. The real challenge is to find out where those under-served areas of the market lie. The markets are evolving, investors are evolving, and so we have to keep staying relevant. It is important to keep your eye on the markets, investors and their demographics, and your competitors.
Another challenge is that the distribution model is changing as well, so you have to keep your eye on that. The client base is changing; the intermediaries and their clients are changing also.
I also think there are more smart-beta products coming. We’ve already hit the large buckets – large-cap equity, international equity, mid-/small-cap equity and so on. Fixed income has a fairly blank slate. I think there are $7 billion of assets in smart-beta fixed-income right now. If you extrapolate out fixed-income ETFs to 2020, you can ask yourself, “What if smart beta became the same percentage of fixed income that is in equities right now at 25%?” That is a $200 billion dollar opportunity. Smart beta will also likely start to permeate other asset classes.
ETFdb: Fixed-income ETFs is one of the stories of the 2016 years with almost $43 billion going into that space. Is this a case of liquidity transformation – where liquidity challenged securities are being prepackaged into liquid securities – or is this liquidity all just an illusion?
M.K.: An ETF is as liquid as the least liquid constituent in the basket. You cannot magically create liquidity. I think ETFs can be a much better leading indicator of liquidity when it comes to fixed income. If you see a bond ETF trading at a discount to its NAV, it is a very likely indicator of where the bonds in the basket should be priced. The ETF wrapper, overall, is not magically going to create liquidity.
ETFdb: What would be your best piece of advice for investors in this market environment?
M.K.: I think you have to do your due diligence – manager due diligence as well as index due diligence. I think that managers are less important in the equity space, because many of the baskets are 100 percent replicable and much of the creation/redemption is done in kind. In the fixed-income space, I think you need to look at the pedigree and capabilities of the manager, of the overall team and of the overall setup. This is because you are negotiating baskets a little more; the underlying bond securities are traded over-the-counter and there is limited transparency as dealers act as market makers, directly negotiating buy and sell prices.
The Bottom Line
Nuveen’s new ETF, the NuShares Enhanced Yield US Aggregate Bond ETF (NUAG), is designed to be a core fixed-income holding that looks to boost yield without adding extra duration or diminishing credit quality. Nuveen sees more smart-beta products coming into the fixed-income space, as it’s a $200 billion market ready for the taking.