Thursday, February 15, 2018

New-to-Market: OCIO

Thursday, February 15, 2018 - New-to-Market: This blog series highlights ETFs that have recently gone public and reflect those strategies currently most in demand by investors. While ETFs are not eligible for ETFG Risk Ratings until traded for 3 months and ETFG Reward Ratings for 12 months, our goal is to highlight the most cutting-edge investment strategies that have recently embraced the ETF structure – we hope you enjoy this special series of posts!

You may not be able to judge a book by its cover, but anyone who follows the ETP industry as closely as we do, knows that when it comes to ETPs, that is exactly what you are supposed to do. There is a set formula to naming a fund; first, you add the benchmark, then throw in the investment style or what was being excluded from the fund, maybe a pinch of something trendy and voila, you no longer have to even read the one-pager! Silly as that may sound, with 276 new products launched in 2017, it’s more important than ever to find a way to standout from the crowd. However, we believe in going the extra mile which is why for our first “New-to-Market” post of 2018, we decided to focus on a fund with the most abbreviated name in the most overlooked sector to hit our desk in a long time, the ClearShares OCIO ETF (OCIO) to see if you really can judge a book by its cover.

Allocation funds, specifically multi-asset funds, probably seem a strange place to start another year of New-to-Market posts given our focus on finding new and innovative strategies, something most investors would consider to be sorely lacking in a space they think is dominated by passive 60/40 funds charging pennies in fees. Allocation funds have long been a backwater of the ETP universe for any number of reasons, but chief among them is the combination of performance and cost that has left many of their intended users looking for alternatives. Originally intended as low-cost core holdings, most allocation funds are built as fund-of-funds products, layering in an additional level of fees that often leaves the allocation ETP at a disadvantage to their less-expensive mutual fund peers in the fee-sensitive market. Throw in that the retail Financial Advisor has long been conditioned to either using in-house products or those offering trailing fees and the inability of multi-asset funds to find an audience begins to come into focus.

Still, the sector has seen a steady stream of new funds come to market in the last few years, many of them actively managed, although the clear trend has been away from offering core allocation funds in favor of more specialized products. The focus has been on unique strategies that help smaller sponsors stand out in a space where potential buyers will either stay with the largest funds or those offered by their custodian. Most are either focused on producing income, managing risk or are more tactically minded for those brave souls not willing to go 120% in equities. Add in the fact we’re nine years into a strong bull market that has investors chasing returns, not planning for 20 years out, and now would seem to be an odd time to bring a new fund to this space.

Enter OCIO, which as you can guess stands for “outsourced chief investment officer,” the first fund offering from Clearshares, a subsidiary of Clearbrook Global Advisors. What do they bring to the table?  A long history both as a money manager and consultant who in recent years has seen a steady increase in demand for their outsourced CIO services as more institutional investors realize that the key to long-term performance is more about recognizing what you don’t know and how to plan around that. While trying to grasp the size of the OCIO market is difficult, Clearbrook has found a working formula as the company is currently advising over $28 billion in assets while OCIO itself has already taken in $100 million to make it one of the larger funds with a broad mandate in the multi-asset space in less than a year of trading.

That level of commitment would serve as a major vote of confidence for a new fund in any category, but for a fund like OCIO, it could prove to be the key to survival in a very competitive arena. Like many of the funds in the allocation space, OCIO is an actively managed product which for most ETP investors is a big enough challenge to embrace, but the fact that fund doesn’t have a well-defined benchmark and you can see why we might think of OCIO as revolutionary. In fact, OCIO is missing most of the attributes investors think of as common in new funds; no formulaic investment strategy, no limited universe to draw investments from and no preset dates for rebalancing. What a brave new world indeed.

Instead Clearshares had a simple goal when they decided to bring this product to market; to marry the asset allocation expertise and independence of the outsourced Chief Investment Officer with the price and efficiency of the ETP and without each acquiring the worst traits of the other. How that translates into a working product begins with the benchmark where instead of comparing their performance to a specific index, the focus is on outperforming the na├»ve 60/40 portfolio, here using MSCI ACWI and the Barclays U.S. Agg for the equity and fixed income positions. As you would expect with active management, there are no preset rebalancing dates or formula, instead the fund has a broad mandate that allows it hold onto strong performers although no one fund can be more than 5% of the fund.  Instead of rebalancing the fund by calendar which can lead to less-than-ideal developments like selling stocks to buy bonds in a bull market, OCIO has a certain latitude to let those winners keep riding. Equities can make up anywhere from 40%-70% of the fund while bonds can be up to 50%, while alternatives, including REITs and MLPs, can be up to 20%.

To turn the old adage on its head, “While that may all sound good in theory, how does it work in practice?”  Our new-to-market posts typically feature funds long on promise but short on track records and OCIO is no exception, although we think comparing OCIO with a more traditional core allocation fund, here the iShares Core Growth Allocation ETF (AOR), can offer valuable insights for going forward. AOR is the epitome of a passive core fund which makes it the perfect contrast to OCIO. Not only does it follow a formulaic strategy, but it also has set rebalancing dates and relies on a handful of broad-based iShares products with no ability to use more specialized sectors.

So how have they matched up so far?  Starting with its historical performance, OCIO was launched in late June of last year, giving it slightly better than a six-month history but during the period there were several significant developments in financial markets including rising Treasury yields and a weakening dollar which could help an actively managed fund outshine its passive peers. OCIO managed to deliver with an 11% return from inception to the end of January, compared to a 10% return for its blended benchmark thanks in no small part to the funds ability to keep equity exposure close to 70% while the bond portfolio had slightly less duration than AGG. That might seem anemic to some but compared to the iShares Core Growth Allocation ETF (AOR) which while charging a slightly lower fee (.25% compared to OCIO’s .67%) delivered a 10% return with the roughly same equity exposure and you start to get a very different perspective on OCIO.

A tiebreaker would obviously come down to who did better with less risk, something vitally important to all long-term investors, but we would offer that it might be important to consider whether an active or passive strategy is more likely to have excess risk going forward. It’s impossible to determine these things ex ante, but given the recent rise in bond yields while equities have become so choppy would suggest that the ability to tactically shift between not just sectors but between markets and investment products could offer a better risk-adjusted return going forward. Only time will tell, but the launch of OCIO could signify that much needed change is finally coming to a long-overlooked space.

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