What You Don't Own Matters: Active ETFs in Today's Market
Industry veteran Lara Crigger sat down with Dodd Kittsley, National Director of Davis Advisors, at the ETF Oasis at Future Proof to talk active ETF growth and the potential benefits of truly active strategies in today’s markets. The following is a transcript of their conversation.
Active in a Time of Concentration
Lara Crigger: After years of passive being king of the investment heap, active ETFs are exploding in popularity and inflows, of course. So what has changed? Why now, and why are advisors embracing active management in an ETF wrapper specifically?
Dodd Kittsley: I think the lightbulb has really gone on for the industry, and more importantly for investors. Look, the ETF is a wrapper. The investment discipline is the product, or the deliverable. So for years, ETFs were synonymous with indexing, and that made sense. We’ve been in the ETF industry now in the US since ’93, so that’s a long time.
Lara Crigger: Since the beginning of ETFs.
Dodd Kittsley: Yes. Right up until recently, active ETFs were really not a proven product. We were among the first, ten years ago. We did it the hard way, before 6c‑11 and exemptive relief and all of those things, which made the barriers to entry drop a lot. That is why you are seeing a lot of products. But I think the flows speak for themselves. The lightbulb has gone on. People recognize that ETFs are not just about indexing. They are about providing a more efficient way to get exposures, and those exposures are not just indexes or markets, they are strategies. One could argue that the ETF structure actually lends itself to add more efficiencies to active strategies than even passive. So a lot of things came together, and it has been amazing.
Lara Crigger: Tell us a little bit more about that. How does the ETF wrapper make active management strategies more efficient for the end investor?
Dodd Kittsley: A lot of active strategies, and I know it is a broad bucket, but when I say active I am really talking fundamental, human element, judgment, decision, where experience comes into play. Timing on those sort of things for changes can certainly be done in a tax‑efficient manner with the ETF structure, to help provide a more fair way for investors to defer taxes and not have unanticipated capital gains, irrespective of their holding periods. So they are able to do that. I think the fact that you have no cash position required, because you do not have to manage cash flows in and out.
Think about it. If you are a portfolio manager for a mutual fund, you do not know what is going to happen the next day. You might have good news that you have $500 million coming in, but then you have to put it to work, and then there are costs. And who bears that cost but all the shareholders. Same thing on the redemptions. You might be forced to liquidate all your positions, or maybe reduce your cash position, so you do not need that anymore. There is a whole host of reasons why ETFs offer advantages to the end investor, and you all have done a great job educating on that. I think there are as many for portfolio managers as well, that help them deliver value to your clients.
Lara Crigger: It makes a lot of sense. So with major indexes increasingly being concentrated in just a handful of companies, how should advisors think differently about what diversification really means?
Dodd Kittsley: I think diversification can be around approach and strategy as well. So one of the things that we urge advisors and investors to do is really to take a deeper look within their portfolios and overlap. Does every US equity dollar need to be allocated market cap wise? What we offer with DUSA and our actively managed ETFs is concentration. We are intentionally trying to have active share that is different in a different type of exposure.
So by going with the right active, that is differentiated enough from the index, you can add that extra level of diversification in terms of return streams and in terms of risk. For example, the biggest concerns are concentration, but more importantly high valuation concentration. And DUSA has got a forward P/E of 13.3 versus the market at close to 20, and even the Russell 1000 Value at a higher historical number than normal. So you are really able to hone in on where there are great opportunities in a market where I think what you don’t own is going to be as important as what you do.
Lara Crigger: That’s fair. So active management, when you look at it across the long time frame, it has a bit of a mixed record. Why should an advisor believe that Davis has a different one?
Dodd Kittsley: It is a great question. I will first acknowledge, look, indexing and what ETFs have done to bring indexing to everyone, being on an exchange and getting exposure to indexing, it is one of the greatest innovations, I think, that we have ever had in the financial services industry. It has really increased our toolbox to be able to get exposures in an efficient way, in a diversified way, that was previously only available to the largest institutions.
What Davis can do, and what active managers can do, is provide something different. You cannot expect a different result by doing the same thing that everyone else is doing, or by creating something starting with an index and tweaking it here or there. That is not going to add a lot of value. What we start with is looking at the best businesses that are around, the economics of those businesses, the sustainability of their earnings, and putting a very rigorous price valuation discipline on there.
So again, with 28 holdings, with uber selectivity, what we are offering is something very, very different and I think it solves for a lot of the concerns that are on everyone’s mind today with higher valuations, a market that is maybe a little long in the tooth overall, and being really selective on companies that are going to do well whether we have an economic recession or not.
Lara Crigger: All right, last question for you briefly. If an advisor remembers only one thing about DUSA from this conversation, what should it be?
Dodd Kittsley: DUSA is research driven, and it is intended for the long term. And it is focused, bottom‑up, research driven, to give you exposure to the best businesses.
Lara Crigger: All right. Thank you so much, Dodd. It has been a pleasure, and I hope you enjoy the rest of your Future Proof.
Dodd Kittsley: Thank you very much. You too.
Disclosures
Before investing in the Davis ETFs, you should carefully consider the investment objectives, risks, charges, and expenses of the Funds. The prospectus and summary prospectus contains this and other information about the Funds. You can obtain performance information and a current prospectus and summary prospectus by visiting davisetfs.com or calling 8002790279. Please read the prospectus or summary prospectus carefully before investing or sending money. Investing involves risks including possible loss of principal.
Shares of Davis Select U.S. Equity ETF (DUSA) are bought and sold at market price (not NAV) and are not individually redeemed from the ETF. There can be no guarantee that an active trading market for ETF shares will develop or be maintained, or that their listing will continue or remain unchanged. Buying or selling ETF shares on an exchange may require the payment of brokerage commissions and frequent trading may incur brokerage costs that detract significantly from investment returns.
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