As a result of a recent decision by the Securities and Exchange Commission, the debate over transparency in actively managed exchange-traded products has splashed back into the headlines. The key question is whether there is a benefit to investors in not knowing the contents of their portfolios on a daily basis. In our opinion, daily transparency is one of the primary reasons why investors consider exchange-traded funds (ETFs).
WisdomTree launched its first actively managed ETFs in May 2008. Since that time, we believe that transparency has served a variety of useful purposes. Principal among them is that it gives investors a unique insight in to what the portfolio manager is thinking. In our experience, daily transparency has enhanced the dialogue between advisors and investment managers, raising questions such as: In the case of corporate bonds, what sectors look attractive? How much interest rate risk should this portfolio target? Are investors being sufficiently compensated for assuming credit risk in high-yield investments versus investment-grade corporate bonds? What countries, developed or emerging, seem to provide the most interesting opportunities? What individual companies seem attractive when compared with their competition? Additionally, transparency can potentially help investors balance risk in other parts of their portfolios: How large is aggregate exposure across this portfolio to any individual company?
In today’s market environment, avoiding the losers may be as important as investing in winners, particularly during a shift in U.S. monetary policy. With the low-hanging fruit of the credit cycle potentially picked, having a fundamentally focused investment process could assist investors in navigating the markets. In our view, focusing on fundamentals may help investors add a potential margin of error to their investment process. However, the skills required for analyzing credit may differ drastically from those needed to position portfolios in equity markets.
Credit Spreads: U.S. vs. Emerging Markets (EM) [in Basis Points (bp)]
Click credit ratings for definitions of credit ratings.
As we show in the tables above, credit spreads have generally widened so far this year. However, the market’s perception of high-credit quality borrowers in emerging markets has actually improved, decreasing credit spreads. Additionally, BBB-rated credits have outperformed A-rated credits in the U.S. Due to a variety of factors, credit may not always be priced in a linear fashion. This is precisely why WisdomTree chose to partner with Western Asset Management Company (“Western”) to launch actively managed corporate bond strategies. As part of its investment process, Western relies on teams of analysts that seek to identify the risks ultimately worth taking in a portfolio. As a result, it may be possible to exploit these divergences in pricing or avoid the pitfalls of agnostic credit investing, all in a transparent structure.
Ultimately, the underlying approaches to portfolio management in actively managed ETFs are largely the same approaches that many managers have historically employed in other investment wrappers. In the case of ETFs, portfolio turnover may tend to be lower, and the portfolio may skew toward more liquid securities in certain instances, but the overall DNA remains intact.