The view from the top

A: Well, you’ve talked about the wrappers – ETFs and mutual funds – but we also think about the content. The key at Invesco is being able to take different strategies and put them in the most appropriate wrapper. Recently, we have seen more growth in ETFs – I think that’s just mirrored the overall industry trend, whether it’s due to pricing or tax advantages. Frankly, from an Invesco perspective, we see the use of both – it really depends on what the [financial] advisor’s clients are trying to achieve. Increasingly, we’re seeing both being used together.

Q: Is there a danger that proliferation of choice in ETFs will lead to investor confusion?

A: Yes, that is a worry. On one hand, innovation and experimenting with different types of strategies is a healthy process, but I do think you can get to the point of diminishing returns. There’s a lot on an advisor’s plate in terms of understanding [his or her] clients, building their relationships and looking at the other parts of financial planning. So, when it comes to the investments, we need to be concise and supportive. And while we’ve led with products, we’re arriving at a tipping point, at which education and having the right tools for advisors really is starting to take priority.

Q: There is a movement toward a greater degree of discretionary active management as well as “smart beta” and factor investing within ETFs. Where does PowerShares stand on this trend vs passive index investing?

A: We’ve really been at the forefront of what we call “smart beta.” PowerShares began with factor investing almost 14 years ago, really before the terms “smart beta” or “strategic beta” were around. About 10 years ago, when Invesco purchased PowerShares, we had the advantages of scale and infrastructure, but also the investment culture of active management.

We were not looking to be just a market cap-weighted, bulk-beta provider of ETFs. We wanted to differentiate. PowerShares’ smart beta/factor strategies married well with the active [portfolio management] philosophy of Invesco. Today, we continue to work closely with a number of our colleagues at Invesco in areas such as senior bank loans or real estate. We really do leverage that active-management world.

We can take that content and put it into transparent indices for ETFs, [which] obviously are lower-priced.

Q: When we get away from ETFs based on market benchmarks, are there higher risks?

A: That really depends. Whenever we’re thinking about new products, our focus always is to think of diversified portfolios. So, what is the advisor trying to achieve for the client? That’s really the idea of solutions and goals-based investing.

If we can find a new strategy or idea that can get help with diversification or find a useful correlation with other parts of the portfolio, then that’s valuable. If we can build something in the smart beta or factor area that helps take volatility out of the existing portfolio or maybe helps generate more income, that’s value added.

I emphasize that this is not something for which we take a short-term, market-timing view. If you’re able to add a low-volatility strategy to tilt a portfolio in a certain direction over a long period of time, that’s going to help you better diversify and meet your goals.

Q: But do advisors actually understand the underlying ETFs and what’s in them? Do they know the product well enough? Is that becoming more challenging?

A: It is challenging, but at PowerShares we partner with some of the leading index providers, such as [Standard and Poor’s Financial Services LLC] and others around the world who help us educate. And also, we’re fully transparent. Every day you can look and see what holdings are in our ETFs, and how often we rebalance.

Clearly, performance attribution is important, and we’re able to explain that to advisors and their clients. The next level of education is being able to provide portfolio advice and help advisors put these products into a portfolio model and understand what the potential implications might be. We do a lot of seminars, conferences and one-on-one meetings. And, increasingly, we want to build more of these portfolio-construction tools onto our website and offer digital access.

We do offer in the U.S. a service of taking portfolios from advisors and analyzing them on a factor basis to understand where there could be potential improvements or changes in favour of the client. All of those tools and models really are going to continue to develop in the [ETF] industry.

Q: What are the latest trends in product development at PowerShares?

A: We’ve had a lot of success with multiple factors based on our history as a firm with single-factor products. We’ve begun to pair factors – for example, low volatility with high dividends has been a good combination. We’re starting to think of other combination pairs that could come out.

Long-term, we think fixed-income is an area that is going to have higher growth. We’ve already seen the interest-rate cycle in the U.S. move up; we think you’re eventually going to see rising rates in other parts of the world.

So, how can you maintain that important fixed-income diversification in the face of rising interest rates? I think shorter-duration products and floating-rate exposures are going to be important, as well as our alternative range of ETFs. We continue to build on things such as commodities and REITs.

Q: Are ETFs best suited to certain asset classes or sectors, such as fixed-income, emerging markets or alternative strategies?

A: If you had talked to me 10 years ago, I would have said [ETFs] are very well suited to equities; now, I would say there is strong growth ahead for fixed-income. Fixed-income is an over-the-counter instrument for the most part. You have to go dealer-to-dealer to trade, and a single company can have multiple issuances of debt and bonds outstanding. That complication in fixed-income was a real issue five or 10 years ago. But now, we’re really beginning to see that the ETF has become an efficient wrapper for fixed-income.

Probably the next movement will be in the alternative space. We’ve seen commodities futures become popular, [as well as] REIT strategies and real estate. And that’s where I think factor investing is beginning to bring hedge-fund strategies to ETFs. If you think about momentum and low volatility, these are popular hedge-fund strategies we’re now beginning to harvest into the ETF wrapper.

Q: What do you think of the robo-advisor trend? Is that a channel for PowerShares?

A: Yes, PowerShares ETFs are used on some robo platforms. Our parent company, Invesco, actually purchased a digital advisor, or robo-firm, in January 2016 called Jemstep [Inc.], so, clearly, we are partnering closely with them. We think the advent of technology – the digital revolution – clearly is happening in investment management.

And for those advisors who can leverage that technology, we want to be able to offer our products. But technology is one aspect; the asset allocation, along with the underlying fiduciary investment advice, is crucial as well. So, how do you make sure you do the two of them well? We’re trying to bring both to bear in our digital strategy and working with advisors.

Q: Are robo-advisors moving beyond using the basic market cap-weighted ETFs?

A: With the robo industry so new – I would say, “in the pioneering stage” – there is a lot of experimentation. Who are their clients? What is their price point? How do they differentiate? The ETF industry faced that 15 or 20 years ago. Low-cost, market-cap products are a blunt way to go, but until you figure out your differentiation as a service and solutions provider, you lead with low cost.

But as the industry matures from pioneering to early growth, then the differentiation comes in. Simply offering the cheapest form of beta is probably not going to be completely satisfactory to many clients and their advisors. You’re going to want to have more active elements in ETFs, and we’re committed to offering those.

Q: With ETFs focusing on asset class or sector exposure rather than on the merits of individual holdings, will clients – particularly millennials, who may know only ETFs – be less committed in a severe market?

A: If you [as a client] can focus on what you’re trying to achieve through goals-based investing, absolutely there are some wonderful companies that can help you over time. But if you’re more methodical [and have] a great advisor helping you, you’re minimizing the emotion to some degree and trying to think rationally about what you really want to achieve in your life. Then, you choose the best instruments to help you do that rather than just thinking, “I love shopping at Wal-Mart, and therefore I like the stock.”

Rather than falling in love with something, focusing on what you’re trying to achieve in an overall portfolio is better. For most millennials today, their greatest wealth is their human capital [and] their future earnings potential. So, hopefully, most of them are beginning to save something now, but most of their savings will come later. Too much anchoring to individual securities could be a detriment and could lead to doubling down on areas of exposure they know well rather than being a lot more objective.

Q: What are the key risks in the ETF market?

A: Again, [insufficient] education. I look at all the regulation changes and the generational changes that advisors face today, and there is so much on their plate. It’s important to help them keep their clients focused and to educate them. We’re trying to stay one step ahead and provide the education and analytical tools to help advisors provide particular outcomes, because we passionately believe that we offer a diverse range of products that when used correctly, really will help the goals-based investor.

This interview has been edited and condensed.

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