The Employees Retirement System of Texas has $27 billion under management. Michael Clements is its chief trader; his desk handles everything except individual bonds. The Austin-based pension fund has been trading exchange-traded funds for five years and Clements has been with it for 16 years.
AsianInvestor asked Clements about the types of ETFs he trades and about the the potential risks of the market.
Q Which types of ETFs do you trade?
We primarily use equity and fixed income ETFs. We’ve probably been using equity ETFs longer than fixed income ETFs, but in terms of size and scale we’ve probably used fixed income ETFs more heavily. We hold funds such as iShares iBoxx USD High Yield and X-trackers USD High Yield Corporate Bond.
Q Do you use commodity ETFs?
We haven’t so far – we don’t have a commodity portfolio – but it’s always possible we would use them.
Q Do you use sector-focused ETFs?
We have dabbled in them at times, but they often have had issues with liquidity. Then it frequently goes back to the ETF provider and whether we are comfortable with that firm running the product.
Q How about other, newer types of ETFs, such as factor-based or inverse/ leveraged products?
We do have hedge fund allocations but our internal portfolio tends to follow more traditional asset class lines. Our portfolio managers evaluate new ETFs and examine the liquidity and execution side of things. But we’re not heavy users of derivatives-based products.
More smart-beta ETFs are coming out and some of them might look appealing in terms of what we need. But if we can execute those strategies ourselves, efficiently, then we would do that.
Smart beta is another name for quant-based strategies and we run some of those in-house because of our economies of scale. We have sufficient exposure [to such investments] at the moment without using ETFs.
Q Do you invest in Asian assets and, if so, do you use ETFs to get such exposure?
Yes, for example, the Wisdomtree Japan hedged ETF, the iShares MSCI South Korea ETF and the Dow Jones Asia ex-Japan ETF.
Q Do you hold any ETFs tracking Asian fixed income?
We’ve never disclosed any in our 13Fs [its public filing of portfolio holdings] but [that] doesn’t mean we can’t or wouldn’t. Even if it’s not a portion of our investment mandate, we’re always looking for opportunities that we can most effectively monetise via ETFs.
Q Do you trade any ETFs listed outside the US?
The ETF marketplace has taken off so much in the US that we’ve thus far been able to get any Europe- or Asia-specific ETFs we need listed in the US. We have the ability to do non-US listed ETF trades if we think it is advantageous.
Q Some people have raised concerns about potential systemic risk or volatility caused by ‘herding’ into certain securities by index products. Do you see this as an issue?
We keep an eye on it. But herding has been going on since tulip bulbs [during the tulip mania period from 1634-1637 in the Netherlands], and likely before that too. The increased utilisation of funds based on benchmarks would seem to increase the danger, but ETFs have an arbitrage mechanism to pull them back in line, while mutual funds do not.
The popularity of ETFs has enhanced price discovery and exacerbated quicker market moves, especially in less liquid instruments such as high-yield [bonds].
The underlying benchmark may not appropriately reflect sudden market changes, since such a high percentage of the high-yield bonds don’t actually trade very often. You’re seeing the impact sooner in the ETFs because people can express their investment views faster and more cheaply. The benchmark’s prices often catch up to the ETF.
So in terms of herding I think the real issue comes down to counterparty risk on ETNs [exchange-traded notes], where the product is not holding the actual securities but [rather] derivatives or some synthetic of the securities. If you have a provider of an ETN suffering a company-wide issue, then you might see an ETN blow up.
ETFs themselves are just reflecting people’s views of markets and they make it easier and more cost-effective to reflect those views.
Michael Clements will be speaking at the Inside ETFs Asia forum, which will take place in Hong Kong on Wednesday, November 8. For more details, please contact Terry Rayner on [email protected] or +852 3175 1963.