Richard Yarlott, partner at Integral Asset Management, talks to Charlotte Moore about the importance of finding the best asset allocation and how ETFs can efficiently serve this purpose
Tell us more about the philosophy behind Integral?
My long career in fund management means that I’m well aware of the advantages and disadvantages of active versus passive investing. The reality is that it’s extremely difficult to add value as an active manager if you have either a global mandate or you’re running a fund in a developed market like the US or the UK. Numerous studies of stock picking have shown that 90% to 100% of the value created in any portfolio is down to being in the right market at the right time. When it comes to total return investing or balanced investing, stock picking really doesn’t make a difference; it’s much more important to put your assets in the right markets. So Integral aims to get the best possible asset allocation through a combination of high quality data sources and thoroughly tried and tested algorithms that can determine how much money should be invested in each market.
What makes Integral different from other asset allocators?
Our philosophy is to take an equally-weighted view of the world so we compile the same amount of data for Taiwan, for example, as for the US. The mainstream data providers, like Bloomberg, do not provide this sort of data. We’ve downloaded huge volumes of information to create 25-year long data series for 50 countries and regions around the world, effectively building a proprietary database. Then we developed our own algorithms to find out which combinations of these database series have predictive power. The system works; we have an audited real cash track record of generating 14% returns per annum in sterling over the last decade.
How do ETFs help you to implement your asset allocation strategy?
One reason why we formed the company is because ETFs could give us the coverage we needed in all markets at low cost. Once you can invest anywhere in the world at low cost, the question becomes where should I put my money?
How does Integral advise its clients which ETFs they should use?
Integral focuses on three different asset classes – equities, bonds and currency. We maintain a database of around 1,000 different ETFs following those asset classes. When, for example, the computer throws up a buy signal on Chinese equities then we will compare different ETFs that cover that market and compare key metrics like liquidity, daily turnover, total size and tracking error to select the best funds. We also have to take into account the tax base of the client as that can influence which ETF they should buy. We do our homework on the ETFs.
Are there any types of ETFs that you prefer or any that you would avoid?
We only look at cash-based ETFs, not swap-based ones, and we do not use those with any element of leverage. While we pay attention to tracking error, we don’t get too hung up on it. If you are investing in 25 different ETFs, small differences in tracking error will cancel each other out.
Are there any asset classes especially suited to ETFs?
As we’re only interested in equities, bonds and currency, we only look at ETFs tracking these asset classes in the 50 countries and regions that we follow. Equity ETFs are the most advanced as there are a huge number of them. As well as ETFs replicating major benchmark indices, there is also a growing number of ETFs that follow equity sub-sectors which we may advise our clients to use. For example, we might be bearish on the US overall, but think there are reasons to be cheerful about US growth stocks or US transport stocks. While bond ETFs currently lag the equity universe, they are growing rapidly. However, if there isn’t an ETF for a particular bond market, it’s not really a problem as it is easy to buy the long market. We only focus on government bonds as corporate bonds are difficult to evaluate on a collective basis. We also think the best way to gain corporate exposure is through equities. Currency ETFs are plentiful, but if there aren’t any on the currencies we are seeking, it’s not a hindrance as it is extremely easy to buy currencies.
Are there any developments in the ETF market that you find intriguing?
When it comes to buying ETFs, I like to apply Benjamin Graham’s maxim for selecting company shares: “If you are shopping for common stocks, choose them the way you would buy groceries, not the way you would buy perfume.” So we look for the ETF that offers the best quality for the best value. We try to maintain a rational distance and not fall too much in love with any one product. We like to keep our choice of investments simple. I am excited, however, about being able to trade ETFs for 0% commission in the US and I look forward to this spreading around the world.
Is the expanding range of ETFs and number of investors a good or bad thing?
The professionals know that you need to really delve under the bonnet before investing in an ETF. I’m sure that people will be tempted over time to over-complicate essentially a very simple structure. As these instruments become more popular, it’s inevitable that someone who doesn’t do their homework will be caught out.
Richard Yarlott is one of the three founding partners of Integral Asset Management and has been a non-executive director for over ten years. Prior to the start of 2010, Yarlott was chief executive of Fabien Pictet and Partners, the emerging markets specialist fund manager. Before this, he worked at Pictet heading up the smaller companies fund management team.
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