The current market environment requires that investors seek
income and fight inflation at the same time and, thankfully, a
growing variety of ETFs make that completely possible, David
Mazza, head of ETF investment strategy for State Street Global
Advisors, said in an interview.
IndexUniverse Correspondent Cinthia Murphy caught up with
Mazza on the sidelines of last week's Morningstar ETF conference,
where Mazza also argued that rising correlations in asset markets
have a lot more to do with the uncertain macroeconomic
environment than with the broad accessibility of the ETF.
Murphy:If we look at the markets in general, it seems
investors are seeking yield as well as inflation protection these
days. Do you see these two factors as driving forces in the ETF
space right now?
I do. It's actually interesting:One would think that income
generation-or the need for it-and inflation protection might be
mutually exclusive. But in today's investment market, and the ETF's
ability to harness that market, those two elements have actually
began to converge.
With central banks having policies to keep interest rates at
very low levels, traditional sources of income have now been
compressed for years, and regulators are basically signaling to the
market that that compression will remain. That's created the need
for investors to think of income from a global perspective-from a
total portfolio perspective. There's no longer going to be just one
source of income.
It's no longer just about fixed income or equities. Now, within
equities, you have to start thinking about whether you need a tilt
for dividends to have a portfolio that has a greater focus on
current income rather than capital appreciation, but one that still
has that potential for capital appreciation. Within fixed
income-which we often think of as a more traditional source of
income-we have already seen this year big inflows into high-yield
ETFs like JNK, HYG, and now we have begun to see interest in FEZ,
which is a euro stocks portfolio.
The income potential from FEZ is very good:49 out of its 50
companies pay dividends. They also tend to be high-quality global
brands that, while domiciled in countries like France or Germany,
are still selling to many markets. They are global in scope, and
therefore have the ability to weather the negative headlines coming
out of Europe.
Murphy:How does the growing concern over inflation play
Taking that back to the inflation side, yes, you don't need to
necessarily see actual inflation coming through. The way CPI might
be measured could be low for the next six months, the next year or
the next two years. But the expectation component has certainly
risen. Investors might be thinking:"Do I need to brace for that
potential inflation environment now? Do I need to look at all the
sources of inflation protection again?" And that protection comes
from REITs, TIPs, global natural-resource equities and
What's interesting is that within that real assets suite,
investors have the ability to tilt portfolios toward things that
may actually be driven more by expectations such as equities and
commodities versus those that are driven by inflation risk such as
TIPS where you actually see the coupon change. So, I think these
two things are coming together at this point in time, which is kind
Murphy:Do you put currencies in that inflation-combating
Our firm doesn't have currencies in our real-assets portfolios
because currencies are somewhat different. I think that where the
currencies story comes in is in the idea of gold as a currency.
Investors have well-understood that gold was always considered a
currency historically, but because it's taken out of the earth,
it's also like a commodity.
What's interesting is that gold's actual return paths and
volatility profile may show that it's somewhat different than a
traditional commodity and even a traditional precious metal. That's
why in today's environment, the idea of gold having some currency
component, or being a potential replacement for the exposure, that
you as an investor may have to have different currencies has been
garnering greater attention.
Murphy:Is this a market where smart beta makes more and
more sense as it allows investors to express so many different
views in a very uncertain economic time?
I think the reason why we are seeing a proliferation of product
development and increased usage from investors of this
advanced-indexing approach is indeed for those reasons you are
pointing out. But in the end, the need for diversification keeps
coming up. That's truly what matters for any kind of investor.
The ability to have more precise exposure to low-volatility
equities, or dividend-paying equities, or to be able to tilt
portfolios toward something that may make sense in a particular
market-all of these things are increasingly important. We are
beginning to see that growth expand, the interest is there, and
from a product development perspective, it may certainly be an area
of increased focus for many firms.
Murphy:As far as diversification goes, much has been said
about rising correlation among asset classes, and many have
suggested that ETFs play a part in that phenomenon. Where do you
stand on that issue?
What I would say about ETFs and correlation is that correlation is
driven by the macroeconomic environment, in research that I've
done. The reason is that ETFs are a vehicle that investors can use;
they really provide access to different market environments. The
correlation of stocks has certainly risen, I won't deny that. But
going back to before ETFs even existed, we saw periods when
correlation spiked, such as during the crash of 1987, or during
periods like the Great Depression. What you do see is that when
those periods of uncertainty are removed from the market,
correlation decreases again. Through thick and thin,
Recently, the growth of ETFs such as SPY and other funds has
less correlation to the market environment than things like
consumer confidence indices, or initial jobless claims. What you
see is that consumer confidence tends to decrease a lot during
recessionary periods, and in periods of uncertainty, correlation
increases. There's somewhat of an inverse relationship. If jobless
claims are trending upward, and kind of peaking, correlation might
be peaking at the same time.
This year is a great example of that. The year started off with a
little bit of a higher correlation environment, but more recently,
some of the worst-case fears related to Europe have been removed
from the market, and correlation has decreased; it is now closer to
just above historical averages-the historical average is about
0.25, 0.26 from 1993 to August 2012, and at last check is about
0.33. That's much more reasonable than what you'd have seen a year
ago when the S&P downgraded the U.S., a time when some of the
highest correlation of individual stocks ever was observed.
ETFs, because they have transparency, cost efficiency, liquidity
and tax efficiency, allow investors to transact and get exposure to
markets that may be more difficult to access at first blush,
because it's a market that's driven by macroeconomic concerns. I
think ETFs really provide access to all types of investors to be
able to perform well or have the potential to perform well in
markets of that nature. So, ETFs can help diversify and help
investors navigate difficult markets.
Murphy:Let's talk about SPY. It's headed for its 20
anniversary. What are some of the lessons from its 20-year
It's remarkable to think about the story of SPY, having humble
beginnings in 1993 and the growth that's been seen through today.
And it's funny because you can tie a lot of the ETF growth to these
periods of stress in the market. While the AUM in the ETF has been
steadily growing, when the shocks happened, investors realized that
this ETF would have allowed for things like intraday trading, and
broad-based exposure to the U.S. market very easily, so you can
look at SPY's growth as a staircase, meaning it might look gradual,
but those uncertain periods really allowed for boosts in
Going forward, SPY is called the granddad of ETFs for a
reason:1) it's the first; 2) it's the largest and most liquid
security in the world. And it's really become a part of the
financial ecosystem. It offers investors the ability to transact in
a way that they couldn't before. And I think that all of the
benefits that have driven ETF growth for the past 20 years will
continue to make sense in the next 20-transparency, liquidity,
cost-efficiency, ease of use. From an investment environment
standpoint, I don't see those benefits going away.
Murphy:Without taking away from SPY's success story, it's
also interesting that almost 60 percent of SSgA's ETF assets are
tied to only two funds:SPY and GLD. Does that concern
We are very proud of the growth of SPY and GLD, and we are not
embarrassed to admit it. But I would say that sometimes that large
AUM and that huge growth mask some of our other products that have
seen tremendous growth over the years. Funds like JNK, or the
Select Sector ETF suite, and industry ETFs. But when you have SPY
and GLD, everything else may actually pale in comparison. So we
like to look at not just flows on an absolute basis, but flows as
percentage of assets.
One example of our success, for instance, is FEZ, which is close
to $1 billion, and it started the year with far fewer assets; these
are pockets in our product lineup that investors are beginning to
notice. The liquidity side of SPY and GLD will remain paramount for
investors, but the rest of our lineup is certainly diverse and
robust; we have 114 ETFs now, with over $300 billion in assets. Our
growth opportunities are very strong.
Murphy:Are actively managed ETFs one of those areas for growth
opportunities as far as product development goes?
While it's still early days with our active asset allocation ETFs,
we do see this as a potential area of growth. We are taking the
benefits of ETFs as passive underlying vehicles to showcase our
institutional asset management capability. We've been managing
portfolios for many years such as endowments and foundations,
through the ETF space. The opportunity set there is quite
Murphy:Tell me your view on the ongoing price war among ETF
providers-most recently headlined by Vanguard's move to drop MSCI
indexes in 22 funds for lower-cost benchmarks. Is SSgA going to
fight to keep sector SPDRs the cheapest in market?
From an investment standpoint, the decrease of expense ratios is
great. Investors are now able to access products at a cheaper
fashion. But expense ratios are just one component of the ETF due
diligence framework. What index is being used? What's the
underlying methodology? Does the fund manager have the ability to
track it and replicate it? And also from liquidity side, while you
could have a very-low-cost ETF, does it actually trade? Is your
total cost actually higher because you need to trade it, say, on a
monthly basis? Expense ratio gets a lot of headline attention, but
to me, there's a lot more to the ETF story than just expense
SPDR Barclays Capital High Yield Bond ETF (NYSEArca:JNK)
iShares iBoxx $ High Yield Corporate Bond Fund
SPDR Euro Stoxx 50 ETF (NYSEArca:FEZ)
SPDR S&P 500 ETF (NYSEArca:SPY)
SPDR Gold Shares (NYSEArca:GLD)
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