ETF Expert Corner

Vanguard’s Matt Jiannino Highlights New Suite of Factor ETFs

March 6th, 2018 by ETF Store Staff

Matt Jiannino, Head of Quantitative Equity Product Management at Vanguard, goes in-depth on their new suite of factor-based ETFs.



Transcript

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

Nate Geraci: Our guest today is Matt Jiannino, Head of Quantitative Equity Product Management at Vanguard. Back in February, Vanguard launched a new suite of six factor ETFs. These are all actively managed, rules-based strategies - notably, Vanguard's first active ETFs in the US. And, in typical Vanguard fashion, these ETFs were launched at extremely low price points. 13 basis points for their single factor ETFs, and 18 basis points for their multi-factor ETF, all of which we'll discuss here today. Matt is joining us via phone from Malvern, Pennsylvania. Matt, our pleasure to have you on the program.

Matt Jiannino: Thank you for having me.

Nate Geraci: Matt, let's first discuss the background on these ETFs. I think Vanguard is probably best known as a low-cost, plain vanilla index fund provider, although nearly a quarter of Vanguard's assets are in actively managed funds as well. But what was the thought process behind launching this suite of factor ETFs?

Matt Jiannino: Yeah, that's an important point. We've got a long history of active, and we really see these as active products. You can think about all the technology and the ability now for investors to look at their portfolios, not just along two factors, size and value, they can now look at their portfolios through multi-factor. And so, for us, it was important to provide investors with additional tools to help them reach their goals and objectives. For us, these products sit right alongside our index products, our traditional active products, and as a way for investors to get exposure to factors, if they choose to, in their portfolios.

Nate Geraci: So, as I mentioned, Vanguard launched five single factor strategies. These cover value, quality, momentum, liquidity and minimum volatility. Why target these specific factors?

Matt Jiannino: For us, it was really ... first of all, there needs to be an economic rationale for them to exist. There's been a lot of academic research behind these factors. Practitioners have been using them for a long time. If you think about what active managers do in their portfolios, they've been trying to get exposure to these types of factors in order to add value over the long term. Our thinking is that now you can look at your portfolio and say, "Exactly what am I paying this active manager for?" And providing investors with a low-cost way to get exposure, if that's what they were looking for, to a factor. With our managers, we also have low-cost actives for those investors who are looking to potentially add alpha over that factor.

Nate Geraci: Alright, so I thought it might be helpful to take a closer look at a couple of the single factor ETFs. We're not going to go into detail on all of them today, but let's look at the Vanguard US Value Factor ETF, ticker symbol VFVA. Walk us through the methodology here. How are holdings selected? How are they weighted? Anything else note-worthy about this ETF?

Matt Jiannino: Sure. So, we are trying to ... Unlike, I would say, some other products out there, we're trying to get exposure to the factor across the entire cap spectrum. Our belief is that these factors exist in large-cap, mid-cap and small-cap, which is one of the important things for us. So, what we're going to do is we're going to divide, actually, the market up into three parts: large, mid and small. We're then going to weight the security or look at the security's exposure to three different valuation metrics. We're going to look at forward earnings yield, or P/E. We're going to look at what we call "forward book yield", or price-to-book as most investors know it. And then forward cashflow yield, or price-to-cashflow as most investors know it. The securities are then going to be scored on those individual factors, and then we're going to come up with an overall valuation score for the security. It will then weight the security in the portfolio based on their exposure to the factor. What we're going to do is take about one-third of the overall market cap from each of those different groups, but in the end, it ends up being about one-third of the securities. The big difference is we're not going to look at market cap, where we're actually weighting the stocks in the portfolio. They're actually going to be weighted based on their exposure to the factor. The goal is to get as much exposure to that factor as we possibly can.

Nate Geraci: Matt, I'm curious, how different is this from the Vanguard Value ETF, ticker symbol VTV, which is a very popular ETF?

Matt Jiannino: I think the difference is that with a market cap weighting, you're taking the market's view of what value is. So, you're going to allow that portfolio to be market cap weighted. You're going to get exposure to value. You're going to probably have a better tracking to the overall market in that portfolio, so it really all depends on what the investor is looking to achieve in their portfolio. With this factor fund, you're going to get a lot more exposure to the value factor. So, if you're trying to tilt your portfolio towards value and you really want that exposure, that's what you're going to get with this factor fund.

Nate Geraci: Our guest today is Matt Jiannino, Head of Quantitative Equity Product Management at Vanguard. We're discussing the new factor-based ETFs Vanguard launched back in February. Matt, as I looked across this new suite of ETFs, perhaps the ETF I found most interesting was the Vanguard US Liquidity Factor ETF, ticker symbol VFLQ. I'm not sure there are any other ETFs out there attempting to do what this ETF does. Can you just take us through this ETF at a high level?

Matt Jiannino: Sure. Yeah, I agree with you. That's probably our most differentiated product. When we've looked, really, at the small-cap space, we tried ... I would say when we looked at all of our factors, what we wanted to find were factors that work across the entire cap spectrum. When we look at small-cap, we really see small-cap as almost multi-factor. If you think about it, when you buy small-cap, you're getting exposure potentially to value, you're getting exposure sometimes to momentum, you might be getting exposure to growth. You are also getting exposure to liquidity, and the one thing about liquidity is you see it as a factor both in mid-cap and large-cap stocks. If you buy the less liquid names in the large-cap space, they tend to long term outperform the more liquid names. We liken it, really ... If you think about what you're trying to get with, say, private equity or physical assets like real estate, part of what you're buying is that liquidity premium. You're getting paid to hold a less liquid asset. Well, that premium also exists in the really liquid stock market. There are investors who want the ability to trade quickly in and out of securities. So, if you're willing to have the patience to hold less liquid - we're not talking about illiquid names here, we're talking about less liquid names - in your portfolio, you can get compensated long term.

Jason Lank: Matt, this is Jason Lank. One of the more notable attributes of these ETFs is the rebalance methodology. Many funds, and not just factor ETFs, have a mechanical calendar-based system where quarterly or semi-annually they'll rerun the algorithms and reposition the portfolio. My understanding is that you have a different approach to that. How do you rebalance, and why are you different than many of the other ETFs out there?

Matt Jiannino: That's a good question. I mean, for us, these things I mentioned in the beginning are active. We are deviating from a market cap weight in these portfolios, and, in our view, as soon as you do that, you have made an active decision. So, we actually treat these portfolios the same way we would treat the active money that we've run for Vanguard for decades. What we want to be able to do is, first of all, keep exposure to the factor through time. So, as soon as you rebalance a portfolio, you're not market cap weighted, so the market's not going to adjust that portfolio for you. What's going to happen is your exposure to the factor is going to begin to decay. What we want to be able to do is give our portfolio managers the flexibility to rebalance their portfolios as needed to maintain exposure to the factor itself. The other thing you think of is cashflow comes in. They can invest that cashflow into the current factor, not the factor as it might have been struck by an index a quarter ago, six months ago, a year ago. They also, if you think about trading in these securities, they have the flexibility to trade as needed. So, if a security happens to be a little bit less liquid in the market today, they can wait. They can determine when best to trade, basically leveraging all the skill that they have from running actively managed portfolios.

Jason Lank: Matt, that really leads me to my follow-up question. When you're dealing with potentially less liquid securities, certainly there are trading concerns trying to move in and out of positions, but something else comes to mind. Since you have the freedom to rebalance on demand, you can perhaps address the issue of front-running. One of the magic attributes of ETFs is that daily transparency, but you're also putting your secret sauce on display for all of your competitors. Is that a concern at all, or is that just a mistaken concern?

Matt Jiannino: For us, I mean, I think that that's an important point. I talk about these being active but for us, as rules-based and transparent, we're going to be open, like you said, both about the way we're constructing these products and, as you've mentioned, we have to show the holdings daily. The issue - there is no rebalance date for us. So, whenever the portfolio manager really feels like they need to turn over their portfolio to regain exposure, they can't. The other thing is - a couple of things - I talk about the portfolios, even with our liquidity factor, we're doing things to make sure we maintain liquidity in all of these products. So we're going to screen out the most illiquid names before we even build our portfolios. But even if, for example, a name becomes less liquid in the market and it's in our portfolio, the portfolio manager, like I said, can decide when to trade. They can hold onto a security. It's not going to... If you think about the way the portfolio's being constructed, it's probably not going to impact the exposure overall to the factor. So, they can trade out of that security over time and be very patient in the way they run the portfolio.

Nate Geraci: Again, our guest today is Matt Jiannino, Head of Quantitative Equity Product Management at Vanguard. Matt, I want to make sure we touch on the multi-factor strategy as well, the Vanguard US Multi-Factor ETF, ticker symbol VFMF. What's the overall goal here?

Matt Jiannino: Really it's for investors... I think that single factors in a portfolio play a role for those investors who have a strong conviction in a single factor. They're looking to achieve an objective, potentially offsetting risk, they want to tilt. They may be substituting for a high cost manager that they have. I see multi-factor as playing that role for those investors... they're really not sure what they want to do. They don't want to buy a traditional active manager, but they want to try and outperform the market. What the multi-factor does is put factors together in a portfolio to get exposure to multi-factor. In this product, what we're doing is we're going to combine value, momentum, and quality in what we're calling... it's called a "bottom-up framework". So, you can think about top-down as when you're combining single factor portfolios together. So you could go buy a value ETF, go buy a momentum, go buy a quality ETF and combine them. What you get is you get the returns to those single factors alone. When you run a bottom-up combination of those factors, what you get is the interaction of those different signals. So you're getting a security that has a little bit of momentum, a little bit of value, a little bit of quality. You could think about buying a high quality firm at a fairly cheap price that has a little bit of a catalyst behind it. That's what you get with the multi-factor fund, and that's what we're trying to provide to investors.

Nate Geraci: Matt, along these lines, going back to the single factor ETFs, if you were to boil this down, how should investors think about using the Vanguard single factor ETFs in a portfolio?

Matt Jiannino: I think the easiest one that I'll start with is the Minimum Volatility Fund ETF. That ETF is really... those investors who want exposure to the market, but may not want the overall volatility that comes from the market. That one plays a specific defensive role in a portfolio, much like investors may be using sector funds or dividend funds in order to try and reduce overall volatility and be defensive. The Minimum Volatility Fund is built to do that for investors. With the single factor funds, I see it really as... Look, I have a high conviction in momentum, so I'm going to tilt my client's portfolios towards momentum and extract that premium from the market long term. They also play a role... I've had this value manager in my portfolio. I'm really not happy with him, but I'd like to have that value exposure so I can substitute in now a value factor at low cost and get exposure to that factor that I want. The other role, which is what we are calling - it's kind of like a completion or what's happening is I may have five growth managers that I'm really happy with, but I'm not real comfortable about having all that growth exposure. I might buy a value factor, add it into my portfolio to offset that exposure long term.

Nate Geraci: Matt, as I think about investors potentially evaluating the factor ETFs that are out there - as I'm sure you're aware, there are a lot of factor-based ETFs on the market and certainly more will be coming to market - I just think for the average investor, it can be extremely difficult to make heads or tails of some of these strategies. From a due diligence perspective, what are some of the key aspects you think investors should consider when evaluating factor ETFs as a whole?

Matt Jiannino: Yeah. I think that's exactly right. These are... I think the first thing to do is, whether it's being provided by Vanguard as an active product or by an index provider, they're active. So they should be looking at an index provider as an active portfolio manager and evaluating them in that way and the decisions that they make in constructing that index. What universe are they starting with? What metrics are they using to try and capture the factor? How are they weighting the securities in the portfolio? Are they taking... Are they sector to industry neutral? What risk constraints are they putting, and what are the implications of those constraints? And, really, what experience do they have in running these types of portfolios or building these types of indexing? Do they have the research behind what they're doing? So, it's really... There's a lot, like you said, that goes into this, and people should be thinking about these things as active and doing the same level of due diligence they would if they're trying to buy an active manager.

Nate Geraci: I think I know how you're going to answer this, but I've got to ask you, any thoughts on the term "smart beta"?

Matt Jiannino: We think of these things... Really, I mean, smart beta has become the catch-all term for these types of products. We're specifically launching factor products and providing investors with the ability to get exposure to a factor in their portfolio. I think that that really... that name is the objective and is much clearer than calling something smart beta.

Nate Geraci: Lastly, can you just talk about the cost of these ETFs? We know low cost is always central to Vanguard's approach. That's certainly the case here with these ETFs. Just talk about the price point.

Matt Jiannino: We're at 13 basis points for the single factor products and at 18 basis points for the multi-factor product. And, as with any Vanguard product, we're obviously going to be trying to... we're going to run these products at what it costs us to run them as a firm.

Nate Geraci: Well, Matt, with that we'll have to leave it there. Thank you very much for joining us on the program today and congratulations on the launch of these new factor ETFs.

Matt Jiannino: Oh, thank you so much. Thank you for having me.

Nate Geraci: That was Matt Jiannino, head of Quantitative Equity Product Management at Vanguard.