Vice Chairman & Chief Investment Officer at TrimTabs, Ted Theodore, shares his investment philosophy and the reasons for focusing on high quality companies in our discussion. In particular, Mr. Theodore talks about how his investment philosophy translates into the TrimTabs ETFs and why the strategy is so appealing. He also talks about his views on the trends in the ETF industry.
ETFdb.com: Please tell us a little bit about yourself and about the career trajectory that led you to becoming chief investment officer at TrimTabs.
Ted Theodore (T.T.): My investment career has largely been one of two simultaneous tracks: portfolio management and strategic research. In addition to time-honored individual security selection, I’ve also been a user of all the major derivative securities, and for the last two decades, ETFs as well. My clients have ranged from individual investors to institutions as I’ve worked in the very biggest shops, such as Citibank and Morgan Stanley, as well as in much smaller ones. I also have deep roots in the research space, which has been instrumental; in fact, I authored the first published research on growth vs. value investing while at Morgan Stanley.
Strategy of the TrimTabs All Cap International Free-Cash-Flow ETF (TTAI)
ETFdb.com: What is the strategy behind TTAI? What makes it so appealing?
T.T.: Our investment philosophy focuses on investing in high quality companies for the long term. The challenge today is being as sure as possible that a company does indeed have that quality. The reason for the challenge is that regular corporate accounting reports are too often misrepresenting actual corporate circumstances. We have found that the way to increase your odds is to focus on corporate free cash flow, a metric which provides measurably more reliability than earnings reports. We combine free cash flow with strong balance sheets to round out that high quality requirement. Finally, because we are shareholders, we like to have a bigger piece of the pie and that points us toward companies that are reducing their share counts. In all, the combination of these three factors should improve our odds of finding really good investments.
ETFdb.com: How does TTAI fit into an existing portfolio?
T.T.: TTAI is focused on non-U.S. companies in developed countries. So, as a first consideration, TTAI represents a diversification from the U.S. market. Our portfolio management process adds another element for diversification. We typically have 85 companies in the portfolio and they are each equally weighted at time of inclusion. As it turns out, having that number of stocks and the equal weighting suggests that a good use of the fund is as a core holding where investors just want general market exposure. We tend to provide that, along with the characteristics of quality we referred to earlier.
Use our Head-to-Head ETF Comparison tool to compare the two TrimTabs ETFs, TTAI and TTAC, and to find out the difference between them on a variety of criteria such as performance, AUM, trading volume and expenses.
Bottom-Up vs. Top-Down
ETFdb.com: What type of environments are better suited for bottom-up vs. top-down strategies?
T.T.: Usually, when the macro environment is particularly challenging, a top-down strategy has worked well. In a sense, the differences between companies are seen as less important than their common exposure to the macro concerns. But as macro issues recede, those differences in company performance become more important. Investors then take up the analysis from a bottoms-up perspective. One measure of this kind of cyclical emphasis shows up in the degree to which stock prices are correlated. When that measure rises, you can be reasonably sure that macro concerns are outweighing company prospects. And as correlations fall, the individual prospects for companies take on more importance. Interestingly, despite the heightened concerns of many, the last few quarters have seen a general decline in correlations.
Active vs. Passive
ETFdb.com: How has the active vs. passive debate evolved most recently in the ETF world?
T.T.: Some argue that because of the growing number of professional investors, the likelihood of standing out against that competition has diminished dramatically. Indeed, the record of active managers being able to outperform their benchmarks is quite poor. On closer inspection, a major portion of this disappointing performance is directly related to the level of fees charged by the manager. Thus, probably the biggest shift by investors has been to lower fee products, and they have been increasingly passively managed, which, of course, is possible because higher priced stock selection talent is bypassed. There has been, as a result, a dramatic compression of fees in the ETF world.
ETFdb.com: What role will robo advisors play in shaping ETF distribution trends for active ETFs?
T.T.: The phenomenon of robo advisors naturally selects away from active ETFs. The essence of robo advice is its reliance on historical performance as a way of predicting future performance. Of course, there is no guarantee that the past will continue into the future. And few, if any, of the off-the-shelf robo advisory products even try to judge whether an active manager will be one of the minority that delivers above-average performance.
ETFdb.com: Why is a man-robo hybrid approach to investing more appealing than being purely passive or chaotically active?
T.T.: All investing is active in the sense that decisions must be made at several junctures in the process. Is it bonds or stocks? A decision of some sort is needed. Just because an algorithm could make the “decision” does not mean that the algorithm invented itself. We’re not yet at that stage of artificial intelligence. Also, we take issue with the notion that being active requires it to be “chaotic.” Our process is rules-based and extremely influenced by a quantitative set of factors, about as far from chaotic as one could envision.
Lower ETF Fees
ETFdb.com: How might the ongoing “fee wars” across index-based products impact active ETFs, which are by nature higher-priced?
T.T.: There has been fee compression across all products, passive or active. TrimTabs tries to position its offerings at below-average fee levels for each product class. We are very efficiently organized and are able to offer the chance for good value received by our clients. With that said, higher-priced active ETFs will likely struggle to win over cost-conscious investors as fees for index-based products inevitably drift lower.
Check out the list of the 100 lowest expense ratio ETFs here.
Free Cash Flow vs. Other Smart-Beta Factors
ETFdb.com: What is the difference between focusing on factors like free cash flow vs. more popular smart-beta factors like volatility or size?
T.T.: The academic literature has been dominated by the “smart-beta” factors mentioned. However, while not as widely explored as they have been, free cash flow, strong balance sheets and reduced share count are confirmed individually in the research. Our use of the combination of the three, while different, was not just the result of throwing randomly selected factors into a backtest optimizer. Instead, we made a decision that makes intuitive sense. And that is the first rule of model building: Have a reason for your approach.
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The Bottom Line
The recently launched TrimTabs All Cap International Free-Cash-Flow (TTAI) offers investors exposure to international high quality companies with strong corporate free cash flow. Since the holdings are non-U.S., it offers the opportunity for diversification. The ETF is active, but offers a relatively competitive expense ratio. As Mr. Theodore mentioned, “TrimTabs tries to position its offerings at below average fee levels” and they are aware that ETF fees in the industry as a whole are compressing.
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