Nasdaq interviewed John P. Reese, founder of Validea Capital Management and advisor to the Validea Market Legends ETF (VALX), to learn more about this ETF and what makes it special.
1.) What ETF is Validea launching and why?
We’re very excited about the launch of our new ETF – the Validea Market Legends ETF – which will trade on the NASDAQ under the ticker symbol VALX. For the last 10 years, thousands of investors have become familiar with Validea’s investment approach and models, which utilize the strategies of Wall Street Legends. By offering an ETF product, now anyone who has followed us or believes in our investing system can invest in our strategy through the ETF.
2.) What is the strategy behind this new ETF?
At the core of our investment strategy is a stock-selection system that utilizes the methods of great investors with proven long-term records of success and market outperformance. We have studied the stock-picking techniques of these individuals, who include investing greats like Warren Buffett, Ben Graham, John Neff and many others, and captured their published fundamental strategies in computer models. In total, we have 22 unique strategies we run. We have been running most of them in model form since 2003, and many in real-time since 2005. The Validea Market Legends ETF will utilize a blended approach, combining ten unique models with approaches ranging from value to growth to income-based, with each model selecting ten stocks to be part of the ETF portfolio. The result is a 100-stock, active equity strategy that looks very different from the major indices and has an objective of outperforming the market over the long term by focusing on fundamental and systematic stock selection.
John P. Reese3.) Why this ETF at this particular time?
Since the 2008 financial crisis, investors have continued to shun active managers and move money into lower cost index funds. For most investors, utilizing index funds as part of their strategy makes perfect sense. However, we think our active approach brings investors the best of both worlds. This disciplined, emotion-free approach brings the fund one of the major benefits of an indexed approach, while its proven methods for active stock-selection bring the benefits of active management to the portfolio. The Validea Market Legends ETF brings all of these qualities to investors, and our belief is that over time the fund will generate strong results that will reward shareholders who stay committed to and believe in our philosophy and investment approach.
4.) How does this ETF differ from other products? What makes it unique?
To be a successful money manager our belief is that you have to be different and you have to maintain discipline in your investment approach, even during the periods when a strategy falls out of favor. In terms of what makes us different from other products, it is that our ETF will be built on strategies of great investors that have proven to work over time. The stocks selected by these strategies are not solely in the large-, mid- or small-cap space; instead the models are free to roam to find the absolute best opportunities across all market segments. This produces a portfolio with a high degree of active share vs. the most commonly followed benchmarks. For example, the Validea Market Legends ETF has 96% active share vs. the S&P 500. This means that only 4% of the holdings in the portfolio are similar to the S&P 500, while 96% of the holdings are materially different in terms of the actual name and/or the weighting in the portfolio itself.
This is important because to beat the market, you have to be different from the market. The researchers who created the term "active share" found that managers with the highest active share have significantly outperformed their benchmarks over the long term. For us, having different holdings than our benchmark is more of a byproduct of our process than a stand-alone goal. Our system tends to key in on overlooked, undervalued stocks that others are either afraid of or unaware of. The rigorous financial and fundamental tests we use to screen thousands of US stocks let us identify those stocks.
The systematic nature of our strategy also makes us different from most active managers. Research has shown that people's emotions and behavioral biases often times hurt returns and cloud decision-making -- they cause people to chase performance, focus on headlines rather than fundamentals, and follow the herd. In fact one study from Dalbar, Inc. shows that over the past two decades the average investor has lagged the S&P 500 by more than 4 percentage points per year, in large part because behavioral biases lead to irrational buying and selling decisions. With our approach, however, we buy and sell only at regularly scheduled intervals and only based on quantitative factors. That ensures emotions and biases don’t play a role in what stocks are being selected for the portfolio or when we buy and sell.
Another difference: Many actively managed equity ETFs in this space utilize just one stock-selection model, but with the Validea Market Legends ETF we’re using 10 different strategies across the value to growth investing style continuum. By blending multiple top-performing strategies, our goal is to beat the market over the long term while smoothing out returns. This way, the periods of short-term underperformance can be tolerated, resulting in the best long-term return for the fund and its investors.
One last differentiating factor is the fees. The fees on the Validea Market Legends ETF will be low for true active management – the cost is 0.79% with no other fees, well below the average cost of actively managed mutual funds and certainly well below the 2-20 model of many hedge funds.
5.) What is your investment approach in managing this ETF?
Our investment approach starts by scoring approximately 2500-3000 stocks using each of our model’s fundamental criteria. These criteria include quality metrics like return on equity and capital, debt metrics like long-term debt vs. net current assets, and valuation metrics like the price/sales and price/earnings ratios. Stocks get a score from 0-100%, with 100% being the best. We then combine the ten top-performing models together, which effectively creates a 100-stock portfolio that is made up of the 10 highest-scoring securities from each of the ten strategies. There are multiple risk controls layered into the portfolio management process, including sector limits, dynamic-stops losses and the equal weighting of positions across the portfolio to ensure diversification. Once the portfolio is put in place, we then follow a highly disciplined and set portfolio rebalancing approach in which we review the holdings once a month. At that time, we remove stocks that have fallen in score or declined in value and replace those securities with higher-scoring names. One of the key ingredients to our approach is that there is a set buy/sell discipline incorporated into the investment management process. Over time, there is an opportunity cost of not holding the top-rated securities. The monthly portfolio review process allows our system to unemotionally get the best values into the portfolio, and do it consistently over time.
6.) Who is the intended primary investor? Retail? Institutional?
At the outset, there will be retail and professional investors who are familiar with our offerings and are followers of our system who will most likely be the primary investors. Over time however we think institutions could find the ETF attractive as well as we build a performance track record and they learn about the robustness of the strategy and the factors that go into making the approach a distinctive one.
7.) How would you characterize the demand for such a product?
We think that over time, investors are looking for investment products that outperform the market after fees, and studies have shown that these products are few and far between. Our goal is to be one of those outperforming products and we think if we accomplish that goal, the demand in the marketplace will be strong. In addition, the fact that our products are based on the strategies of highly successful, legendary investors has been very appealing to both individual and professional investors, and we think that fact will also drive demand for this product.
8.) What is most significant or noteworthy about the fund that both asset managers and investors should know?
A lot of investors don't realize that many great strategists have left blueprints to their stock-selection approaches in published books or papers. Through my experience in computers and artificial intelligence (I was a member of MIT's A.I. laboratory in the late 70s), I was able to turn those gurus' strategies into quantitative models that can sift through thousands of stocks in a matter of seconds. Today, those guru-inspired techniques sit at the heart of our investing approach.
But the system we’ve built wasn’t all just created overnight – we have been running these strategies for over ten years. In the end, we are bottom-up stock pickers who use a unique stock-picking and portfolio management system, and we will always maintain a long-term, disciplined focus when running the portfolio.
9.) How should the individual investor approach this ETF?
This ETF will always be 100% invested in the stock market. Because of that, it is appropriate for individuals who understand that the stock market is the best vehicle available to build long-term wealth, but who also understand that there will be inevitable ups and downs along the way -- and that staying the course during them is the key to long-term investing success. So this ETF is not for the risk-averse investor, but we think it can be a great long-term vehicle for investors who understand the risks of the stock market and who believe in following strategies that have proven themselves over time.
10.) What’s next for Validea Capital?
With the ETF now launched, our focus will be on helping the investor community understand our investing system and our long-term value proposition. This is a highly competitive market, but over time the funds that will be successful will be those that have a sound and unique strategy, can articulate it, and have the conviction to follow the approach during good times and bad. As we continue to build our business and grow, I wouldn’t be surprised to see other ETF products in the pipeline, from Validea so stay tuned!