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Mutual Fund Q&A: 
Actively Managed ETFs
AdvisorShares ETFs
Management: Noah Hamman

Author: Manish Shah
Last Update: 3:45 PM ET April 05 2012


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A growing number of advisors are looking beyond traditional long-only mutual funds and passive index-oriented ETFs to diversify market risks, manager risks and investment strategy risks for their clients. Noah Hamman, founder and CEO of AdvisorShares Investments, explains how the firm’s lineup of actively managed ETFs offers investment expertise that is generally not available to individual investors.

 
Q:  Would you provide an overview of AdvisorShares?

A : We offer actively managed exchange-traded funds with all the benefits of the ETF structure – liquidity, transparency, other operational and tax efficiency – through a team of portfolio managers with distinctive investment strategies. We have thirteen different actively managed ETFs and each strategy has its own sub-advisors selected for their expertise.

As of this moment, we have about $450 million of assets under management.

Q:  Would you discuss some of the actively managed strategies in your lineup?

A :
I would like to begin with Active Bear ETF (HDGE), a strategy designed to short stocks on fundamental valuation and a technical trading strategy. It is the largest of the thirteen strategies that we have right now with $180 million of assets under management.

John Del Vecchio, the fund’s portfolio manager, identifies companies that will have some type of issue, such as failing to meet their earnings expectations, changes in accounting practices or pre-booking of sales, which can cause company earnings to fall short of market expectations. He will short anywhere from 40-50 U.S. equities, which targets the exposure to just those short candidates, not just blindly shorting the entire market, which causes you to short the good stocks as well.

Cambria Global Tactical ETF (GTAA) is our second largest ETF strategy with $100 million of assets under management. This is a global macro tactical investment strategy and utilizes a trend following model.

Another one of our ETF strategies is the Meidell Tactical Advantage ETF (MATH), a tactical asset allocation strategy that invests capital across equities, fixed income and cash depending on the prevailing market environments, aiming to have lower volatility than a traditional long-only portfolio. In down markets, the strategy tends to avoid a significant drawdown while trying to capture as much as possible from upside gains. This is an undiscovered manager who has had solid performance since inception.

Q:  How do you go about selecting managers and subadvisors? What kind of due diligence do you do?

A :
We start by talking with financial advisors, we try to understand what they feel they are missing in their portfolios and what they are not getting from traditional mutual funds and ETFs sponsors.

In terms of analyzing different managers, we use different resources that track different managers’ performance and the type of strategies that they manage. We educate ourselves on the firm as well as their track record and exactly how they manage money.

Next, we spend time with the manager understanding the firm and its compliance infrastructure. We carry out our own analysis of the individual investment strategy in order to understand their portfolio attributes and the types of securities they select.

In our view, the underlying securities that a manager uses need to be liquid as well. The liquidity of an ETF is heavily driven by the underlying security that that manager uses.

Q:  What risk controls do you follow in the different ETF strategies?

A :
In the Active Bear ETF (HDGE), the first thing a manager will do in terms of managing risk is to manage their short concentration, allowing for no more than 5% of the portfolio to be allocated to any one position. If a short position starts exceeding that limit in the portfolio, the manager will pare off the exposure.

The next thing to consider for the portfolio managers is how to avoid shorting securities that are generating a lot of upward momentum. They balance both the fundamental and technical factors by using fundamental aspects for security selection and technical factors to trade in and out of those positions.

On the other hand, the Cambria Global Tactical Asset Allocation Strategy (GTAA) is a trend following model strategy invested in U.S. and international stocks and bonds. It has cash as an asset class but it is invested in other hard or alternative assets, currencies, commodities, and real estate as well. However, the manager is not an individual security selector. What he does is employ a very granular approach to investing at the macro level by looking for large overall trends in a particular category or asset class. That attempt at diversification across categories and his willingness to move to cash in downward trends is, in fact, a component of his risk management process.

Through this consistent process of capturing upward trends and stepping aside from those asset classes in downward trends, this strategy seeks to mitigate risk on the downside, capture a decent amount of upside performance, and provide a client with a very diversified portfolio. So, investors should see lower volatility and higher returns over the long term rather than just a fully invested position.

At the same time, the WCM/BNY Mellon Focused Growth ADR ETF (AADR) is a more traditional long-only international strategy. The first distinguishing feature of this product is the manager. Based in Laguna Beach, California, WCM Investment Management is an institutional money manager for pensions and endowments that an average retail investor or a financial advisor would not normally have access to. That is a big reason why we decided to provide such an opportunity investors of any size by offering that investment strategy in an actively-managed ETF.

What is also interesting about this strategy is that it employs a heavy fundamental process with regard to analyzing different stocks and selecting opportunities internationally. However, they maintain a concentrated portfolio with 25 to 35 positions as their best selections without trying to overdiversify. They have an impressive 7 year track record, and in the almost 2 years AADR has been out, it has beaten its benchmark and a significant number of its peers.

Q:  When do you change a subadvisor?

A :
There are three primary areas that we will consider before making such a move. First of all, we continuously monitor their compliance infrastructure, so if something were to change in that area in a negative way, we would consider a change in the subadvisor.

The second area is performance. Of course, we are fully aware that a bad quarter or a difficult period of six months is not really a reason to have a manager no longer serve a subadvisor. Yet, when we see a consistent underperformance relative to benchmarks then that certainly is going to be an issue.

Last but not least, all of our products have investment guidelines and parameters under which they invest. Since advisors are looking for a manager that approaches the market in a certain way, if the managers started fundamentally changing their approach to investing, that would certainly be an area of concern for us and we would want to look for a different subadvisor for the strategy.

Q:  What do you do to educate advisors about the benefits of exposure to different ETFs?
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