Chief Investment Officer @ IndexIQ
Sal Bruno was one of the early adopters to build portfolios by combining fundamental and quantitative research. It’s a style that has allowed him to manage active and passive investment vehicles and make the best of both worlds.
In his current role as CIO at IndexIQ, he generates new ideas for ETFs and oversees the performance of alternative strategies like hedge fund replication in an ETF wrapper – not an easy sell after the credit crisis – and educates investors to help them make smarter choices and build better portfolios using active and passive strategies.
… organisational changes can provide an opportunity. People are often afraid of them but when the chairs are shifting, it can be a chance to get a better seat!
Bruno talked to Jobs In ETFs about why ETFs are a great option to replicate hedge funds, the evolving responsibilities and challenges that motivate him at work and the best advice he gives to his portfolio management students at Fordham University.
Jobs in ETFs (JE): What was your first job in the ETF industry?
Sal Bruno: Before IndexIQ, I co-managed a US equity mutual fund at Deutsche Asset Management where we put our quantitative and fundamental research skills together. This was between 2005 and 2007; it was still early days for the ETF industry. Our sector analysts were supposed to be picking stocks but due to things like high turnover or a lack of good ideas in the sector, we started looking at ETFs for sector exposure. I learned more about ETFs and their uses as components within a fund as a result.
Fast forward to 2007 and I left Deutsche. I saw what was going on in the mutual fund industry: even then, there was a lot of talk about active versus passive and a lot of active mutual funds that were underperforming while charging higher fees. I thought ETFs were an up-and-coming revolutionary vehicle in the asset management industry and I thought the growth lines would start to move in opposite directions i.e. mutual funds would see outflows and ETFs would see inflows.
Couple that with the fact that I noticed hedge funds had been doing well as they emerged from the tech, media and telecom crisis in the early 2000s. I was looking for an opportunity to go for a smaller, more entrepreneurial firm as Deutsche was a massive company. I found IndexIQ was a start-up with a real entrepreneurial environment and their focus was on hedge fund replication so that was a great opportunity.
JE: Are active managers still using ETFs to get exposure to sectors or has their use of ETFs evolved since 2007?
Sal Bruno: It has evolved significantly.
One, the ETF industry has moved far beyond just equities. SPY was the first ETF and that simply tracked the S&P 500. Then you had bond ETFs in the early 2000s, followed by commodities, currencies, real estate, volatility – it wasn’t called smart beta at this point – but you started to see other asset classes. It wasn’t just sectors anymore, either: it ranged from countries and investment grade bonds to high yield corporate bonds, treasuries and mortgage-backed securities.
Once the asset classes were covered, we saw the next generation of smart beta evolution which tried to employ some of the active strategies in the passive ETF wrapper and maintain the benefits of that wrapper as well as the benefits of the active process.
That two-fold trend is continuing today.
JE: How have you remained a champion of hedge funds and ETFs, given they suffered after the credit crisis?
Sal Bruno: In the 2005 to 2007 period, hedge funds were still doing well and attracting assets. In 2008 they didn’t so fare so well: they did OK relative to the S&P 500 although drawdowns were larger than people expected. There were some liquidity issues during that time and there were some major blow-ups – the biggest was the Bernard Madoff scandal in 2008 – which shook confidence in the industry and it has been dealing with the repercussions of that for the last 10 years.
We take two things from that context, in terms of reconciling how we view the hedge fund industry over the last decade and how it will move forward.
One, hedge fund returns from an absolute level have come down relative to where they were since going into the 2008 crisis, partly because we are in an extremely low rate and low volatility environment. We also have seen hedge funds get bashed due to the very strong performance of both equity and bond markets over the last 10 years – the S&P 500 has more than doubled since March 2009 and we’re looking at a 35-year bull market in bonds. People have traditionally used hedge funds to try to dampen volatility and diversify away from equity and fixed income risk, and recently investors have not needed to do that.
The second point is whether this bull market can continue. It’s more than likely that at some point in the future – I don’t have a crystal ball as to when – equity valuations will be too rich and we will see a sell-off of 10% to 20% and you may see bond rates fall off again. During those periods we expect people will look for hedge fund-type exposures, and we think a great way to do that is through the ETF wrapper, which addresses certain issues like higher fees and transparency. I like to say that the best time to buy an umbrella is when the sun is out, not when it’s raining.
JE: You’ve been at IndexIQ for 10 years, the same amount of time hedge funds have been struggling. Have you had to use the same arguments for that time?
Sal Bruno: I think the argument has become stronger over that time. The more you go into a bull market, the more potential you have for a pull-back. We have always differentiated ourselves from hedge funds, and we have delivered the type of returns we described to clients, and that’s a big reason why we have managed to raise significant assets in some of our hedge fund replication ETFs. Our largest is almost $1.1 billion.
The key here is saying what you expect the funds to do and deliver on that. We set very realistic expectations, rather than promising the moon. We say over the long-term that hedge fund returns should be somewhere between 3% and 6% over the risk-free rate and we have delivered within that range.
JE: Can you describe how you combine fundamental and quantitative research in a single portfolio? It’s interesting as a lot of industry participants tend to swear by one or the other.
Sal Bruno: We built a process, when I was head of quant research at Deutsche Asset Management, to take fundamental research ratings and run them through a quantitative portfolio construction process.
Our research found that fundamental analysts were less good at calling short-term moves. However, the 12 to 18-month outlook should do quite well. We also found that portfolio managers using this fundamental research were often letting emotion get in the way.
I won’t go too much into the maths here but we took the fundamental ratings, risk-adjusted them and calculated the stocks’ expected return on a risk-adjusted basis. We would end up with a numerical value. We take those values and, using a portfolio optimiser or some other quantitative construction technique, create portfolios that had significant outperformance relative to fundamental portfolio managers using the exact same input. I brought this process over with me when I became manager of the mutual fund.
JE: What has kept you at IndexIQ for 10 years and your previous role at Scudder Investments for around 16 years?
Sal Bruno: Continuing challenges. Over my time at Scudder, the firm changed names and became Deutsche Asset Management in 2002. But it was the evolving nature of the role that kept me there. I started off doing operational databases, quant analysis and services before doing more quant research and then moving into portfolio management. It was nice to take what I had learned every few years and move up to the next level. Organisational changes can provide an opportunity. People are often afraid of them but when the chairs are shifting, it can be a chance to get a better seat.
When I left Deutsche, as I said, it was more to get out of the active mutual business and into ETFs and hedge funds at a smaller, more entrepreneurial business and that provided its own challenges. We went from a start-up with no revenue, no clients and very little product to a fully-fledged, profitable firm that we sold to New York Life in 2015.
My role was initially head of research and head of product development. I became the CIO and had the opportunity to work on ETFs in great depth as well as cutting edge products like hedge fund replication and mechanical merger arbitrage. Seeing people invest directly into your ideas has been extremely motivating and rewarding. The performance has sometimes not gone as you would hope, but that is a challenge and it keeps you going.
My role has evolved a lot. Now I focus quite a bit of my time on client education, which includes deep dives for various clients around portfolio construction, speaking engagements at key industry events, and Continuing Education-credit eligible webinars that cover a number of different topics, ranging from ETF primers to conversations on sophisticated multi-factor strategies for institutions, financial advisors and individual investors, all while looking after my investment duties. I still come up with investment ideas and am ultimately responsible as CIO for performance of our strategies, but now I’m part of a team and we have more resources to work on our legacy alternative products and our newer smart beta, equity and fixed income products.
JE: If you could change one thing in this industry to make it easier for ETF issuers to adopt new ideas and run with them, what would it be?
Sal Bruno: The regulatory environment can be challenging at times, whereby certain ideas get painted with a broad brush, such as the use of short exposure or derivatives. They can be viewed as a bad thing. But when used properly, they reduce volatility and can make things safer.
JE: You teach portfolio management to undergraduates at Fordham. What concepts do students struggle with?
Sal Bruno: The first section I teach is basic statistics and how you calculate performance – what is a compounded annual growth rate, what is a geometric return. Then we move into optimisation, modern portfolio theory etc., and we wrap up with performance evaluation and attribution. We teach everything conceptually but I think to learn it properly, it needs to be hands-on. Once the lecture is over, we sit down with our laptops and go through an Excel spreadsheet to show them exactly how to make those calculations.
Even if some students come out of the class not wanting to be a portfolio manager, they come out with much greater Excel skills which are very useful in this industry as so much is still done on spreadsheets.
JE: What do you think is the “next big thing” in terms of innovation in the ETF industry?
Sal Bruno: I think we will see the continued evolution of smart beta and non-market cap-weighted strategies. We’ve been doing a lot of work in fixed income which is still a new area. There are around 300 smart beta equity ETFs yet there are less than 30 smart beta fixed income ETFs with less than $4 billion in assets. There is a lot of room to grow there.
I do think it will be interesting to see how exchange-traded mutual funds take off. Non-transparent ETFs are also interesting and of course you have crypto currencies: in terms of registration status, the SEC hasn’t approved anything yet but it could be an interesting area to watch. You will see the ETF wrapper being used in these areas and you will see more traditional asset managers working out what else they can do in the ETF wrapper without cannibalising their existing business.
JE: This question is particularly relevant for you as a teacher. What advice do you give to people starting out their careers in finance today?
Sal Bruno: Build up your technical skillset and take hands-on classes. When you get into the workplace, employers can teach you the subject matter and how they do things, but they’re not going to teach you how to use a spreadsheet. There are some things you should know coming in.
Try to have a broad understanding of what’s going on, not only in the asset management industry but also in the economy. Ask questions and be thoughtful – a popular argument is not always the right argument. Be willing to put in the hard work and the effort because there are no short-cuts to make it to the top.
I’ve found over time that having good judgement is so important and it helps you to rise within an organisation. That is hard to teach but students can work on that and use other people as sounding boards to make decisions.
The other bit of advice is to think about your personal brand. What do you want to be known as? Think about your personality and skills and consciously seek out opportunities that resonate with you and play to your strengths.