Jobs in ETFs caught up with John Davi founder, CEO and CIO of Astoria Portfolio Advisors in advance of the upcoming ETFGI Global ETFs Insights Summit at The Metropolitan Club, New York April 2. John has 20 years of experience spanning across macro ETF strategy, quantitative research and portfolio construction and we took the opportunity to discuss Astoria’s investment process, non-transparent ETFs, ESG, Coronavirus and the panel on portfolio construction at the upcoming summit.
“Coronavirus is a black swan event but investors should make investment decisions based on empirical evidence as opposed to forecasting. Keep your long term strategic asset allocation hat on and focus on risk-adjusted returns, after-tax, and after-inflation returns. Try to not get emotional over daily price action. It will cloud your judgement.”
Jobs in ETFs (JiE): Can you share your views on current affairs particularly the coronavirus and how they might be impacting the market?
John Davi (JD): First, I’ll take a step back to explain our investment philosophy and the pillars that govern our investment process. We believe in trying to generate attractive risk-adjusted returns on an after-tax and after-inflation basis. Those three pillars – after-tax, after-inflation and risk-adjusted returns are very important. Not many firms focus on all 3.
The technology sector was up 50% last year and you could have made the argument to buy technology stocks. Investors would have generated a very high return, but when you incorporate the risk of technology stocks from a standard deviation, valuation, and positioning standpoint, it might not look as attractive on a risk-adjusted basis. In terms of inflation, whether you look at core PCE or CPI, inflation is running between 1.7% to 2% (and there are other measures showing it above 2%). A 2% inflation drag really impacts your portfolio returns if you have a long-time horizon. After-tax returns is crucial. We are big proponents of tax loss harvesting.
Our investment decisions are based on empirical evidence using datasets that ideally go back 50-75 years. We use quite a bit of factor based ETFs in our portfolios as the research clearly shows that historically you have been able to get higher up on the efficient frontier when harvesting a portfolio of factors over the long run. We utilize numerous portfolio construction tools and risk models to ensure we are getting the desired outcome we want to achieve.
Before I get into the coronavirus, think again about our pillars – we’re long term strategic asset allocators focusing on after-tax, after-inflation, and risk-adjusted returns. We have a 5-step portfolio construction process. Step 1 is defining the goal for the end client which usually translates into one of two things – a desire for growth or a desire for income. As part of Step 1 we ask the advisor if we need to hedge the upside. In short, Step 1 tells us how much equity we should be putting in the portfolio. Step 2 is defining how much risk the advisor will allow us to take. Is 1% tracking error acceptable? How about 2-3%? The answer will dictate whether we need to stick with low cost cheap beta ETFs or if we can utilize ETFs that have higher active share as well as alternatives. Step 3 is determining where we are in the economic cycle. We look at valuations, equity risk premiums, and inflation among other things. Step 4 considers which factors have historically worked at different points of the economic cycle. As mentioned previously, we believe that harvesting a portfolio of factors can generate a better investment experience. Step 4 is crucial because we’ll apply modest factor tilts to the portfolio. Quality is something that we have been advocating and made a tilt to the portfolio 18 – 24 months ago. Step 5 is where we have an edge. Here we will load ETFs into a portfolio risk model to determine how much risk we are taking, analyze if we are getting all the right factor exposures, and ensure each of the ETFs are delivering on what they say they’re trying to do.
JiE: As a long-term strategic asset allocator, how and when do you decide whether to use ETFs, mutual funds, futures, shares etc?
JD: We believe ETFs are the ideal construct for wealth management solutions. They are generally low cost and tax efficient as they don’t typically generate capital gains compared to mutual funds. Futures are leveraged strategies and we shy away from leverage. Stocks are already levered instruments, so we don’t need to add more leverage.
JiE: Non-transparent or periodically disclosed ETFs are very topical at the moment. When and how would you consider using those?
JD: We have produced hundreds of pages of documentation explaining our investment process, our macro-economic views, and why we choose each of our ETFs. This research is all available on our website astoriaadvisors.com. We pride ourselves on being very transparent so owning a non-transparent ETF defeats a crucial element of our value proposition. I understand why mutual fund companies prefer not to disclose their holdings, but it just doesn’t work for us as an investment process discipline. Hence, we don’t envision utilizing them.
JiE: Any thoughts on ESG and ESG development?
JD: ESG is still a very small piece of the assets in the ETF ecosystem. Obviously the assets are much bigger in the mutual fund and the separately managed account space. We’re currently doing research to determine whether ESG has similar portfolio risk characteristics to the quality factor, which I believe that it may have. Companies that exhibit good high quality – high ROE, high ROA, and low financial leverage is a good management discipline to begin with. I’m concerned ESG might be one big quality filter.
Clearly a lot more research is needed on ESG. Just taking an obvious example – you can find Exxon Mobile in one of the ESG ETFs which seems counter intuitive. Investors should utilize portfolio construction tools to ensure they are receiving the desired exposure. Our portfolios consist of more factor-based ETFs, looking at long dated risk premiums that have 50 – 75 years’ worth of underlying data. ESG is a relatively new phenomenon and though we’re not opposed to it, we haven’t utilized it thus far.
JiE: You’ll be speaking at the upcoming ETFGI Global Insights Summit in New York on April 2nd. Tell us a little bit about your session.
JD: I’ll be speaking on a portfolio construction panel outlining the process by which we determine which ETF to utilize. Our edge is combining macro-economic and quantitative research and utilizing portfolio risk models.
I have over two decades of ETF ecosystem experience primarily working closely with large sophisticated institutions. I built optimized portfolios of ETFs for investors going back to the early 2000s. I’m looking forward to discussing that at the conference.
JiE: As you know, Jobs in ETFs is the World’s First ETF career platform so let me ask a career related question – what do you look for in people when hiring?
JD: All of the employees and people involved at Astoria have very complementary skill sets along with strong institutional backgrounds. We have a very collaborative, open culture where we exchange a lot of ideas. We want people that are disciplined, eager to learn and those who are looking to advance their career. We look for problem solvers and people that have strong quantitative skills. We live in a big data world. If you’re going to work on the investment side, it is crucial to understand how to use data and work with large data sets.
JiE: Tell us about some initiatives that you are working on for 2020.
JD: We’re very transparent in our investment process and we’re putting more of our content on our website at astoriaadvisors.com. Here you will find all our research, our bespoke custom solutions, and content. I encourage investors to continue checking our website to track what we’re doing. We have some pretty cool research projects that we’re working on and we look forward to unveiling them in the future.
JiE: Anything that we should be thinking about for 2020?
JD: It’s worth reflecting on the coronavirus. Nearly all of the 2020 outlook research reports were bullish. The majority of these reports talked about more upside in the US, more upside in international markets, particularly emerging markets. Coronavirus is a black swan event but investors should make investment decisions based on empirical evidence as opposed to forecasting.
Keep your long term strategic asset allocation hat on and focus on risk-adjusted returns, after-tax, and after-inflation returns. Try to not get emotional over daily price action. It will cloud your judgement.
I would add that the last 5 – 10 years has seen tremendous outperformance in terms of US stock and US bond outperformance. The next 5 – 10 years should look very different because capital is ultimately allocated trying to deliver the highest return per unit of risk. Look to move away from the 60/40 US stock and US bond portfolio in the future.