[Advisors and investors are starting to look more critically at market indices. Especially in relation to the challenges of navigating today’s new investing environment driven by uncertainty, complexity, and hovering at record high market levels. This allows them to go beyond just relying on past performance, static asset allocation models, or buying the cheapest ETF.
ETFGI - a research and consultancy firm covering trends in the global ETF and ETP ecosystem - reported that Exchange Traded Products had record net inflows in 2020 of $762.87 billion. Within this trend is a growing interest for actively managed ETFs which globally reported 2020 net inflows of $91.2 billion, significantly more than the $42.07 billion in net inflows active ETF products attracted in 2019.
Many of these newer active ETFs are incorporating more of a forensic approach to dig deeper into company fundamentals or shifting macro and industry dynamics, thematic trends, and their associated opportunities. Of particular interest are active ETFs with investment approaches targeted at the heart of today’s business environment of accelerating rates of change, disruptive technologies, business transformation, and innovation.
To explore this growing investment focus on innovation, the Institute reached out to Kim D. Arthur, James W. Concidine, Alex Varner, and J. Richard Fredericks, the portfolio managers at Main Management – an independent, San Francisco based advisory firm that was an early pioneer in managing all-ETF portfolios. Recently they launched an innovation-focused ETF – The Main Thematic Innovation ETF (TMAT). They designed their ETF as an actively managed investment portfolio providing diversification through 10 innovation categories and seeking exposure to technology’s next moves. We wanted to understand their perspective on investing in innovation and why they chose to expand their innovation strategy offerings into the ETF universe.]
Hortz: Having developed and managed an innovation-based investment strategy in separately managed accounts and limited partnership structures, what was behind your decision to expand to an ETF structure?
Arthur: Since our beginning in 2002 we have focused on investing in ETFs. We are very familiar and knowledgeable about that structure and its evolution. We like that the ETF structure provides more transparency for our clients as ETF holdings are updated daily versus a Mutual Fund updating quarterly. It is less expensive for us to run an ETF versus a Mutual Fund and less of an operational challenge. Ultimately, we chose the ETF structure as it provides a lower-cost, tax appealing way to get diversified equity exposure for our clients.
Hortz: Has there been advances in the ETF universe that also appealed to you as an investment manager and what were they?
Arthur: Costs continue to come down and variety of offerings continue to rise. The increase in factor-based and active ETFs has also given us more choices when picking the appropriate vehicle for our innovation strategies. They allow for more specific, targeted exposures which enable us to be more specific and deliberate in our portfolio allocations than many passive ETFs can. With the advent of more sector and thematic ETFs in the marketplace, it made it easier for us to put our innovation strategy into an ETF wrapper ourselves.
Hortz: Investing in innovation would be considered by most as a pedal-to-the-metal growth strategy but that is not your approach. How would you characterize your strategy and mindset as to investing in innovation?
Arthur: In our TMAT ETF, we have a predominantly mid-cap growth strategy with our portfolio being half the price-to-earnings growth (PEG) ratio of the Nasdaq 100 and, separately, not being concentrated in 5-6 stocks. As a fundamental shop, we are applying and adapting our strengths to the thematic space. We recognize that many of the traditional valuations (P/B, P/E, P/S) may be less relevant or even hard to calculate. In some of the innovation areas in which we are investing, the market can have a hard time sizing the total addressable market size of the themes we are using. We are using those traditional metrics where available, but we are also placing an emphasis on growth forecasts - both sales and earnings.
We are combining those growth forecasts with the fundamental valuation metrics to try to back into a price-to-earnings growth ratio. An over-arching goal is to invest in growth at a reasonable price, which is a philosophy we implement across all of our investment strategies. We are not blindly buying growth just for growth’s sake and can be volatile as with all technology and innovation growth investing.
Hortz: How do you apply this Growth-at-a-reasonable-price Value approach in determining your investment decisions between the 10 innovation themes?
Arthur: We look at the various themes and their PEG ratios as well as longer-term growth prospects and make our allocations accordingly. The goal of the strategy is to invest in disruptive technologies with large addressable markets and the potential for long-term exponential growth. Some of the trends currently in the portfolio include solar energy, genomics, autonomous technology & robotics, fintech, online retail, and video gaming.
Hortz: How would you characterize your thematic investing approach and portfolio in contrast to an innovation portfolio focused on choosing individual stocks?
Arthur: By investing in broad themes via ETFs, we do not have to choose individual names. Within themes, there is a lot of single company risk – a company may not survive for any number of reasons – but the odds of an entire theme going out of business are much, much lower. The impact of a single name going under within an ETF portfolio with 40 or so names is decidedly lower than a 5 or 10% direct allocation to a single name in a portfolio. This allows us to spend our time identifying the broad themes we think have the best opportunity to grow and succeed and we do not have to worry about, first, picking a good theme and then, second, identifying the best companies within that theme and assuming that company risk.
Hortz: How do you recommend an advisor work with and allocate your ETF to a client’s portfolio?
Arthur: Each investor’s goals are different, but this strategy likely resides as part of a growth stock allocation. We have seen anywhere from 10-25% of someone’s global portfolio allocated to this type of investment. We would also like to point out that our ETF is very diversified.
At first pass, a thematic strategy might be thought to have considerable overlap with the S&P 500 or NASDAQ, in effect doubling down on those more concentrated indices, but with 360 names represented in our ETF, you get great diversification. The top 10 names in TMAT ETF account for roughly 15% of our innovation portfolio versus 50% or more in some other tech-focused growth portfolios or indices. Exposure to the headline names of Facebook, Apple, Amazon, Microsoft, and Google is less than 4% in our ETF versus the NASDAQ 100’s exposure of 38%.
So, our ETF may be paired with a core, passive equity allocation without doubling down on the concentrations that already exist in that core equity position. Furthermore, the ETF is 60% US and 40% international, so it is more than just US exposure, which adds another element to the diversification benefits.
Hortz: Any other thoughts or recommendations that you can share with advisors about incorporating innovation as an investment theme?
Arthur: Given the dramatic shift and acceleration of technology and the subsequent adoption that has been brought on by the pandemic, it may be prudent to have at least some exposure to innovation. As they say, necessity is the mother of invention, and it certainly became necessary to make changes to our lives when everyone was suddenly told to stay at home. Innovation is not something that is going away any time soon and given the continued exponential gains in areas like computing processing power, it stands to reason that we will see at the very least a continuation, if not an acceleration, in innovation.
Related: Reshaping Risk with Investment Technology to Capture Alpha