ETF Expert Corner

OppenheimerFunds’ Dave Mazza Discusses Smart Beta ETFs

December 5th, 2017 by ETF Store Staff

Dave Mazza, Head of ETF Investment Strategy at OppenheimerFunds, offers perspective on the growing smart beta ETF category, including highlighting Oppenheimer’s revenue weighted and factor-based approach to investing.



Transcript

You can listen to our interview with Dave Mazza by using the above media player or enjoy a full transcription of the interview below.

Nate Geraci: Our guest today is Dave Mazza, Head of ETF Investment Strategy at Oppenheimer. Oppenheimer currently offers 18 ETFs. Those ETFs have nearly $2.5 billion invested in them and Dave is a highly respected ETF industry veteran. He previously headed ETF research for State Street. He was a managing director there. He's frequently quoted in the mainstream financial media. Just a wonderful all-around ETF research. Dave is joining us via phone today from New York. Dave, great to have you back on the program.

Dave Mazza: Hey. Thanks for having me back.

Nate Geraci: Dave, before we discuss Oppenheimer's approach to ETFs, I thought it might be good to hear how you define smart beta. I know this is a much-maligned term. Some people prefer strategic beta or alternative weighting, but whatever you call it, for the average investor when they hear these terms, what should they think of?

Dave Mazza: I think you're spot on. It's a term that investors, some love to hate, others hate to love it, because it might feel new. It kind of has a distinction maybe other types of beta aren't smart. The simplest way that I like to think about it is smart beta takes the best of traditional asset management, meaning strategies looking to outperform a benchmark, and the best of passive management, meaning strategies that can be offered in relatively low-cost, transparent, rules-based manners. By combining the best of both worlds, really putting rules around techniques that managers maybe have used for decades that are not new, is what smart beta is all about. It's doing something that is based in principles, but maybe just doing it in a new way.

Nate Geraci: Dave, I saw a stat last week. According to Bloomberg, U.S. smart beta ETF assets are now at around $680 billion. They've grown sevenfold just over the past decade. I'm curious, what do you attribute that to?

Dave Mazza: What we're seeing with smart beta, and one of the reasons why it's one of the fastest-growing areas in the markets, is that what investors are increasingly focused on, and you noted it in the segment earlier, is what is the price point I'm getting for a particular return stream? With new strategies and tools that investors have, I believe that we can do better for what we're paying than we maybe had historically. Traditionally, an investor maybe had to pay the fees that an active manager had charged to get access to maybe a strategy that looked toward inexpensive companies or high-quality companies, or maybe a combined approach that looked for high-quality, inexpensive companies, for example. With smart beta, I can do that in a rules-based fashion but at a much lower price point. Investors are looking towards strategies of this nature not just for the potential for risk-adjusted returns, but also looking for cost savings as well.

Nate Geraci: Our guest today is Dave Mazza, Head of ETF Investment Strategy at Oppenheimer. Dave, let's talk about Oppenheimer's approach to quote/unquote smart beta ETFs. I want to start with your revenue-weighted ETFs. Oppenheimer pioneered this approach. You offer 10 revenue-weighted ETFs altogether, the most popular of which is the Oppenheimer Large Cap Revenue ETF, ticker symbol RWL. Perhaps using that as an example, explain for us the methodology here and why revenue weighting can be a better way to go.

Dave Mazza: Exactly. Oppenheimer pioneered the revenue-weighted strategies, and really what the impetus here is saying, I can own all the same securities that I would own with a traditional market cap-weighted approach, like the S&P 500, or 400, or 600, but maybe I want to weight them differently, because weighting by market cap is very reliant on market sentiment, because we know market cap is measured by the shares outstanding in the company and by its current price. Shares outstanding, certainly a company could do buybacks, or a company could do a secondary issuance, but it's fairly stable. What's not stable is prices. What can happen from time to time with market cap is that market sentiment becomes a bit exuberant. Maybe the weight of technology, such as in the tech bubble, became much, much greater than it had historically. By focusing on a company's revenues, you're grounding in a fundamental, and you're grounding toward companies in a contrarian fashion that tend to be attractively priced over the long run. It really is a way to still get all the benefits of diversification in your portfolio, take advantage of why indexing tends to work well over the long run, but don't just let market sentiment tell you the weight to own. Let a company's contribution to the economy, based off of their revenues, drive that weight.

Nate Geraci: I'm curious, what makes revenue in particular a good weighting methodology compared to some of the other weighting methodologies that are out there, putting market cap aside?

Dave Mazza: Yeah, exactly. There's a lot of different ways an investor could think about reweighing a security. Maybe I could use a company's earnings, for example, or I could use dividends. Each one of them are going to have pros and cons, but if I compare earnings to revenue, for example, earnings generally is a classic way of looking at how a company is doing. EPS numbers get thrown around the financial media all the time. The one challenge of earnings, though, is that they can be highly cyclical, depending upon the market environment that I'm in. Maybe I'm in a time of booming economies or maybe I'm in a time of more recessionary contraction. Revenues don't move around as much. They tend to be more stable, and conversely, I think maybe even more important, is think about it from the accountant's standpoint. The further I go down a company's income statement, even if I'm not doing anything nefarious, the company is doing things in the right way, I have more potential for manipulation based off of earnings. I don't have that with the top line. Revenue is really anchored in sales, and there's not as much potential for manipulation based off of accounting rules there, as well.

Nate Geraci: One of the criticisms I've heard about a revenue-weighted approach is that it's effectively just providing a smaller-cap value tilt, the argument being that if you want more of a value tilt, for example, you should go invest in a market cap-weighted value ETF. What are your thoughts on that?

Dave Mazza: Most definitely. Again, by anchoring toward a fundamental like revenue, you certainly end up with a portfolio that's more attractively valued than you would by anchoring just on market cap. The difference here, though, is that a traditional market cap-weighted value index, and then an ETF based off of that index, only gives you a small set of the securities in a broad index. You have to be very reliant on “is value in favor?”. Then conversely, usually if it isn't in favor, then growth is in favor. With a revenue-weighted approach, I can still own all the stocks in the index. In the 500, I can own all the 500 stocks there. I end up with a portfolio that's probably about two-third value and one-third growth, but I don't have to make that guessing game between is growth in favor or value in favor and try to make that trade. Revenue will provide me with a more stable return relative to that growth-value trade-off.

Nate Geraci: What's the potential downside to a revenue-weighted methodology?

Dave Mazza: With any type of approach, there's pros and cons. In certain market environments where we tend to see investors focus on a small number of securities, like the tech bubble, or for parts of this year we know there's been a lot of attention on the FANG stocks, or whatever acronym de jour based off of the number of securities that are in the FANG group, but what that's really expressing is that a small number of stocks are gaining investor attention. They're driving most of the returns across the broader market. In those environments, you actually tend to see revenue not do as well than it would over the long term. Why? Because investors are not paying as much attention toward the fundamentals of a company. They're paying much more attention toward future growth expectations. That's an environment where revenue-weighted approaches tend to lag, but what you tend to see is historically investors then rotate away from that a bit, and focus again on fundamentals.

Nate Geraci: Dave, lastly here before we move on, I know Oppenheimer offers revenue-weighted strategies across U.S. large, I mentioned that earlier, U.S. mid and small-caps. There's a dividend strategy which we'll actually be spotlighting later in our show. There's a U.S. financial sector strategy, three international ETFs, and then two ESG ETFs as well. Are all of these effectively the same in terms of how they're constructed, just different areas of market exposure?

Dave Mazza: Exactly. Other than the dividends, which is a bit unique because it's focused more on looking for the highest-yielding securities and then weighted by revenue. What's great about the revenue-weighted methodology, among all the different approaches of smart beta, and Oppenheimer funds offers some that are more complicated, is its simplicity. Whether I'm talking about the international market using MSCI EAFE or I'm talking about the U.S. mid-cap market using the S&P 400 and the underlying universe, it's all the same. The goal is to own all the same stocks, but own them in a different weight than what you're going to end up with just from market cap. For someone who's interested in building an entire portfolio with this focus on avoiding the potential for overvalued sectors or securities to gain too much weight than they would and not focus on economic contribution, the revenue-weighted methodology is a great solution for them.

Nate Geraci: Our guest today is Dave Mazza, Head of ETF Investment Strategy at Oppenheimer. Dave, I do want to be sure to touch on the eight factor-based ETFs Oppenheimer launched back in early November. There are two multi-factor ETFs, and then single-factor ETFs covering quality, size, value, low vol, momentum, and yield. Tell us a little bit about this lineup and how investors might use these ETFs.

Dave Mazza: The way we think about smart beta is that there's three distinct types of smart beta, from our perspective. There's something that's more fundamentally weighted, of which the revenue-weighted suite can fit into. These are again generally simpler to understand, closer to indexing. Single-factor strategies, on the other hand, are really pinpointed, precise exposure to some of the commonly awarded risk premiums that exist through time. For an investor looking just for the least expensive stocks, and always offering the least expensive stocks, I would look toward a single-factor value ETF. Maybe I'm an investor who wants just the highest-quality stocks. I would use a single factor quality ETF. The one challenge and caveat I would give to that is that investors should really think about the intuition between why they own that factor and the fact that they can be very cyclical, meaning the market environment we have been in this year, for example, value stocks have underperformed but quality stocks have done extremely well. An investor really needs to know what they're doing by taking that kind of do-it-yourself approach with single factors. Our multi-factor products, however, are very unique. We actually use information from the broader economy and from the markets to help inform what particular factors may be in favor versus not. Depending upon if we're in an economic recovery or in an economic slowdown, the portfolio may be tilted toward different factors that may do better in that type of environment.

Nate Geraci: Dave, more broadly speaking, when I look at the quote/unquote smart beta or factor ETF space, there are obviously a lot of options out there for investors, and it seems like those options grow by the week. What are some things you think investors should consider when they're evaluating these ETFs? Because I do think it can get a bit overwhelming.

Dave Mazza: You're absolutely right. One thing which smart beta has done is blurred the line between active and passive. As noted earlier, I think there's a lot of benefits that investors can gain from understanding these products. But it's really important that, in the case of smart beta, the term I use is know what you own. As fund providers, as investors, our bias is to look toward performance. How has it done relative to its peers? How has it done relative to other offerings? What I'm more focused on, certainly I'm not going to ignore performance, I'm not going to ignore returns, I want to know what I own. I want to understand the methodology. Meaning, based off the index methodology, what the strategy does needs to be transparent to me - a benefit to the investor, but I need to appreciate that. Meaning if the strategy's looking for systematically companies that offer the highest yields, for example, what do I end up with? I want to know, am I going to end up with a portfolio that's tilted towards certain areas? In an international fund, I would want to understand what country exposures I have. What are the weights of individual securities? What's great is that most ETF providers' websites have all of that information for us, so I could do my homework in a way that I might not have been able to do historically. That's the benefit, but it's incumbent upon us to do that work a bit. It's also then an appreciation for investors to dig in and say, as noted earlier, cost matters, the price that I'm paying, but I have to look at some other things with ETFs as well, such as trading volume or what are the liquidity characteristics as well. Look at the expense ratio, but maybe use some other tools to help understand is this ETF right for me and my goals that I have?

Nate Geraci: Dave, we have about two minutes left here. I'm glad you mentioned cost, because I did want to ask you, last week, Vanguard announced they would be launching several factor-based ETFs early next year. In typical Vanguard fashion, their single-factor ETFs will be positioned at a very low cost, 13 basis points. Obviously fee competition continues to garner a lot of headlines. How do you view this focus on ETF costs from an ETF provider's perspective?

Dave Mazza: I think what's interesting is that as an industry as a whole, because there's greater transparency, and maybe it's the technological innovation that's come with the growth of mobile devices or just generally more focus on information that we have, is that investors are now appreciating again, what am I paying to get a particular service? Maybe the service in this case is an investment return. I think of course that longer-term investors will benefit by lower prices. There's no doubt about that. What I would say, though, is that along the way investors should also look at the tax efficiency of an ETF, especially if I'm comparing two value ETFs relative to another. Don't just look at the expense ratio. Understand the index methodology. Look at the trading volume. Look to see what platforms it may be available on compared to how you engage with the product. Certainly focus on price. That's a good thing, but use some other tools to think about what I would term your total cost of ownership, as well.

Nate Geraci: Dave, I think excellent words of wisdom for any investor. With that, we will have to leave it there. As always, we appreciate you joining us on the program. We certainly look forward to connecting again down the road. Thank you.

Dave Mazza: Thanks for having me.

Nate Geraci: That was Dave Mazza, Head of ETF Investment Strategy at Oppenheimer. If you would like to learn more about the Oppenheimer ETF lineup, you can do so by visiting oppenheimerfunds.com.