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Magellan High Conviction ETF: A Highly Intense Strategy Reshuffles Its Leadership

Approach

This exchange-traded fund is the listed entry point for the unlisted Magellan High Conviction, after converting from a closed-end structure in August 2021. Magellan believes sustainable competitive advantages enable companies to earn lasting returns above their cost of capital. Concentrating on financial services, consumer franchises, IT, healthcare, industrials, and infrastructure trims the universe to about 4,000 names. Quantitative and qualitative screening cuts this down to about 200 stocks. These filters exclude measures incorporating current market prices, although Magellan seeks firms that have enduring competitive advantages, lucrative reinvestment potential, low agency risk, and low business risk to facilitate predictable cash flows. Relying mainly on discounted cash flow techniques, analysts elongate the model’s duration for wide-moat stocks and vice versa. 

Targets must be discounted sufficiently to intrinsic value to give a margin of safety. Stocks are ranked along qualitative and valuation dimensions, from which Magellan constructs an ultraconcentrated portfolio of eight to 12 of the best ideas. Unlike the Magellan Global strategy, there are no hard limits on the portfolio’s “combined risk ratio” (a proprietary risk measure based on historic stock beta and drawdown risk). The portfolio can hold up to 50% cash, which aims to provide protection in a falling market. From November 2020, the portfolio has unhedged currency exposure, having previously been actively hedged based on the managers’ views. Magellan publishes an intraday net asset value on its website to help price discovery. It is calculated using live prices and foreign exchange movements but doesn’t use futures, so it might be a lagging indicator in highly volatile markets. The vehicle targets a spread of 7 basis points on either side, but they can widen notably during volatile periods.

Portfolio

Magellan ignores index weightings when building this ultraconcentrated portfolio of eight to 12 companies. Historically, the manager has tilted towards consumer-related and technology sectors while steering clear of commodities. By its nature, sector concentration is large, and as at January 2022, 62% of the portfolio was exposed to information technology and Internet and e-commerce, while consumer discretionary and financials names accounted for less than 10% each. The manager’s preference for giant-cap multinationals with strong franchise value also leads to a strong bias towards North America. At year-end 2021, the portfolio held only three stocks outside of the United States, with Chinese ecommerce giant Alibaba the portfolio’s smallest holding. 

However, the managers carefully assess the portfolio’s underlying earnings exposure by geography, and on this basis European and emerging-markets ex-China exposure was around 32%. No single position can exceed 20% of the portfolio, and no more than four stocks can be weighted at over 12.5% each. The portfolio can hold up to 50% cash. At the end of 2021, the cash position was 5%. Turnover ranges between 30% and 40% and is lumpy given that a single stock initial purchase or exit represents a sizable trade. Given the strategy’s high level of concentration, it is suitable as a supporting player, composing only part of a more broadly diversified portfolio.

People

CIO Hamish Douglass co-founded Magellan and has been this strategy’s key decision-maker. In February 2022, he announced an indefinite leave of absence due to medical reasons, forcing a new lead portfolio manager. The firm called on Douglass’ co-founder Chris Mackay to step into the lead role as replacement. Mackay was Magellan’s CIO from 2006 inception to 2012, before choosing to focus on managing the listed MFF Capital Investments. At the same time, former head of research Nikki Thomas rejoined Magellan as comanager on the flagship strategy, after departing in 2017 following the decision to cease development of the non-US strategy she managed. Thomas had a four-year stint comanaging Alphinity’s global equities strategy. In early 2018, Chris Wheldon rejoined the group as assistant portfolio manager, concentrating on the High Conviction strategy as comanager. He had previously spent eight years at Magellan working as an analyst in the franchises team and as head of the industrials team, before a stint at US-based Davis Advisors. 

There is the backing of a strong team of investors and analysts, however. This includes Dom Giuliano, who was promoted to deputy CIO in December 2014, and Gerald Stack, who oversees the team as head of investments and is chair of the investment committee. Similarly, portfolio managers Chris Wheldon, Arvid Streimann, and Stefan Marcionetti have experience as a sounding board to Douglass at the portfolio level. 

Performance 

Magellan High Conviction unlisted fund has delivered performance slightly below benchmark and category average since its inception in July 2013 to January 2021. Significant underperformance over 2020 and 2021 has undone the strategy’s respectable track record. Measured over all rolling three-year periods, it outpaced the benchmark over 75% of the time during its history. The returns have also exceeded the manager’s target absolute return of 10% per year. Indeed, 2016 was a setback when positioning into Brexit, then the Trump reflation rally, saw the fund lag the market. This underperformance was more than made up for in 2017 by almost 10% outperformance, driven by holdings in Apple and Facebook. 

The year 2018 was more volatile, but the strategy still managed to achieve a positive return of 3.4% and beat out the benchmark. Notably, however, it lagged the flagship Magellan Global strategy by around 6.4% as the latter’s more-diversified portfolio did better during the more volatile periods of the year. The portfolio kept pace in 2019’s strongly rising market, with many of its tech holdings appreciating significantly. But the strategy’s punchy approach fell significantly behind the index throughout a volatile 2020 market. Active currency hedging also detracted value over the year to October. Fortunes weren’t any better in 2021, trailing the benchmark by a similarly wide margin, as volatility returned to technology names and Alibaba sold-off heavily.

About Fund:

The Magellan High Conviction Trust seeks to invest in outstanding companies at attractive prices, while exercising a deep understanding of the macroeconomic environment to manage investment risk. This vehicle is the listed entry point for the unlisted Magellan High Conviction. CIO Hamish Douglass announced a medical leave of absence from Magellan in February 2022, leaving a big void to fill. His indefinite absence exposes Magellan’s lack of succession planning across the investment team and the broader business. The firm has had to step outside the immediate team, albeit to somewhat familiar faces. Magellan co-founder Chris Mackay returns to the fold as lead manager; he had relinquished the CIO role in 2012 to focus on managing MFF Capital Investments. Portfolio manager Chris Wheldon provides some continuity, having been comanager alongside Douglass since rejoining the firm in 2018 after a stint at a USbased manager. 

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Betashares Western Asset Australian Bond Fund ETF: Diversified Portfolio

Process:

The philosophy of the team is to identify mispricing within sectors and securities, allocating active risk in areas in which it has conviction while ensuring the portfolio remains diversified to avoid singular themes being pervasive through the portfolio. The team takes account of global macro insight from the global investment strategy committee and overlays its domestic market knowledge to come up with a base-case expectation looking forward six to nine months depending upon its conviction. In addition to this, the team develops multiple upside and downside scenarios as a risk-management framework. Based on the base case, the team engages in quantitative and qualitative analysis to determine sector allocation. The quant component is where the team will look at historical and relative spread comparison within and across sectors. The outcomes of this analysis are then overlaid by qualitative insight considering technical demand, credit, and liquidity dynamics. The culmination of this analysis in conjunction with the base-case expectation guides the actual portfolio positions. The fund looks to invest across government, semi government, supranational, credit, inflation-linked bonds, securitised assets, and cash. The team is clear about allocating only active positions where it has a high degree of conviction and an expected positive reward profile. Holdings are disclosed daily. BNDS runs as a separate vehicle to the flagship unlisted fund and has some additional restrictions on the amount of residential mortgage-backed securities it can hold owing to requirements on holdings being issued by a listed entity.

Portfolio:

The portfolio can invest across government, semi government, supranational, credit, securitised assets, inflation-linked bonds, and cash. As of November 2021, more than 40% of the portfolio was invested in investment-grade corporate bonds, around 25% in semi government issues, 20% in government, 10% in supranational, with a small amount of mortgage-backed and asset-backed securities. This allocation has been relatively consistent over time, and cash levels have been low, generally a few percentage points, even in times of stress like the early-2020 market plummet. Relative to the Bloomberg AusBond Composite Index, the fund has been long underweight in government bonds, choosing instead to invest more broadly across spread assets. Given the fund’s constraints, the overall portfolio remains high-quality, with 35% of assets in AAA rated issues, no allocation below investment-grade, and a weighted average credit rating of AA-. Portfolio manager Anthony Kirkham and the Western team have historically been opportunistic within their mandate, though duration is kept within plus or minus 1.0 year relative to the benchmark. Active duration moved short relative to the benchmark around mid-2021 but came back in line with the index around yearend. Like most Australian bond managers, they entered 2021 overweight in credit, indicative of their opportunistic profile. Susquehanna Financial Group is the primary market maker, and bid-ask spreads have remained respectable over its relatively short life, moderately higher than passive Australian bond ETFs, which is to be expected. This vehicle contained about AUD 190 million in February 2022 and can be used as a core defensive allocation.

People:

The fund is managed by a seasoned team of investors who remain dedicated to this strategy. The team is led by Anthony Kirkham, who has had more than 30 years of wider experience, including nearly two decades at Western Asset Management, and leading this strategy since 2002. Kirkham has credit analyst, dealer, and portfolio manager experience working for Commonwealth Bank, Metway Bank, RACV Investments, and Citigroup. He is supported by Damon Shinnick, who is a portfolio manager with a focus on credit portfolios. Shinnick has 22 years of experience within the industry including 11 years at the firm. Shinnick has also held an array of portfolio manager roles previously at Challenger Financial, Lehman Brothers, Pension Corporation LLP, and HSBC. Craig Jendra is also a key member of the team, joining Western in 1996 and being promoted to portfolio manager in 2000. Jendra has 25 years of industry experience with previous roles at Citigroup and JPMorgan. The three portfolio managers are supported by analyst Sean Rogan, who joined in 2002 and has 32 years’ industry experience; dedicated investment dealer Anthony Francis; and portfolio analyst Lawrence Daly, who ensures risk characteristics are maintained and adhered to. Together, the group boasts more than 25 years’ industry experience and is among the most impressive in its peer group.

Performance:

BNDS began in November 2018. It has closely tracked its equivalent unlisted fund strategy, Western Asset Australian Bond, over that span. The long-running unlisted fund has done well over the long term, especially compared with peers. It has delivered returns above the Bloomberg AusBond Composite Index, net of fees, over the past decade. That is ahead of its target return of 75 basis points (gross of fees) over the benchmark and market cycle. A tracking error of 100 basis points is targeted. Perhaps more impressive, though, is that these results put the strategy’s flagship A share class in the first quartile of its Morningstar Category over the trailing three, five, and 10 years to December 2021. Sector allocations and credit exposure continue to drive performance. Most of the outperformance has stemmed from the fund’s allocation to higher-spread assets in lieu of government bonds, especially credit. To put this into context, the portfolio has had around 40%-50%exposure within credit since 2002. Adding the strategy’s allocation to supranationals to the mix, this exposure goes up to almost 60%. While this increases the strategy’s exposure to wider credit spreads, it remains high quality, and the majority of it is shorter-dated to control for spread risk. Owing to the mandate restrictions, the fund can’t and doesn’t take large-duration bets. Duration was the second largest contributor to the portfolio in 2021, but has been a small negative attributor over the long term, largely a result of the fund’s short-duration bias in an environment of shrinking bond yields.

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(Source: Morningstar)

Price:

It’s critical to evaluate expenses, as they come directly out of returns. The share class on this report levies a fee that ranks in its Morningstar category’s middle quintile. That’s not great, but based on our assessment of the fund’s People, Process and Parent pillars in the context of these fees, we think this share class will still be able to deliver positive alpha relative to the category benchmark index, explaining its Morningstar Analyst Rating of Silver.

Table

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(Source : Morningstar)

About Funds:

BetaShares Western Asset Aus Bd ETF BNDS is a compelling choice for domestic fixed-interest exposure owing to its best-in-class team and straightforward approach. BNDS provides daily holdings to the market and has grown steadily since it began in November 2018 with active external market makers. Anthony Kirkham, head of investment/portfolio manager, is the leader of this strategy, and we have high regard for his investment knowledge and skills. Kirkham is supported by an experienced investment team, consisting of Craig Jendra and Damon Shinnick, co-portfolio managers, and Sean Rogan, research analyst. The stability of this group and quality of the research are impressive. There’s appeal to the strategy’s simplistic and relatively conservative investment process, which seeks mispriced domestic fixed-interest securities within various sectors. Sector and issuer limits are applied to help damp volatility in different environments. Still, sector allocation and issuer selection has been strong over the past decade, emphasising the team’s rigourous analysis in these areas. However, this can be a hindrance if yields rise unexpectedly. That said, the portfolio’s active duration was moved around judiciously and contributed strongly in 2021, a testament to the team’s ability to interpret and capitalise on shifting economic conditions. The track record here has also been consistent and solid over multiple time frames, and the annual 0.42% fee is competitive relative to peer

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Actively managed stock ETF-Fidelity Blue Chip Growth FBCG

“(Manager) Sonu Kalra’s willingness to pay high price multiples for companies he thinks have sustain­ably high growth rates courts risk, but over the past decade he’s consistently made good calls. That’s especially been the case within the consumer discre­tionary and communication services sectors.

“Kalra often tries to get in early, initiating modest posi­tions in small or mid-caps with large-cap potential. In 2010, for instance, he built a 20-basis-point stake in electric-car maker Tesla TSLA, when its market cap was roughly $2 billion. Since then—despite oper­ational issues that underpinned many shorter sellers’ theses—Kalra maintained conviction in what he thought was a disruptive industry pioneer.

“The strategy’s present size poses a challenge. Still, that doesn’t necessarily relegate the strategy to mediocrity. Kalra’s position moves tend to be gradual, and analytical support from Fidelity’s deep analyst bench helps in overseeing in the fund’s sprawling portfolio.

“The portfolio in aggregate doesn’t typically look high-quality on traditional metrics such as return on invested capital and return on assets, given Kalra’s tolerance for owning names that may not yet be profit­able. These types of investments can make for bumpy returns. But the types of stocks that make the strategy volatile are often the same ones that have fueled its superb long-term record.”

The open-end and ETF variants of this fund look a bit different. Unlike its mutual fund predecessor, the active nontransparent ETF does not hold Chinese tech conglomerate Tencent because it trades on a non-U.S. exchange. E-cigarette maker Juul Laboratories’ privately held status also precludes it from the ETF’s portfolio. Differences like these caused FBCG to trail the retail shares of its open-end parent by 2.51 percentage points from its June 2020 launch through April 2021.

While FBCG is not an exact replica of its open-end fund parent, its lower fee directly benefits investors. ETF shareholders also dodged a sizable capital gains distribution last December. While ETF investors may wring their hands if the strategy’s privately and/or internationally traded holdings excel, the ETF’s cost and tax benefits provide a unique performance edge of their own.

General Advice Warning
Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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ETFs ETFs Shares Small Cap

Wisdom Tree US Small Cap Dividend ETF

Those with the best-combined quality and momentum characteristics see their weight-adjusted upward by 50%. This dividend-weighting approach places fundamentals front and center.

Indeed, the fund’s return on invested capital, a measure of profitability, exceeded the Russell 2000 Value Index by a wide margin over the trailing five years through April 2021. Profiling stocks based on profitability should aid performance; the quality factor has been historically been tied to market-beating returns.

The fund absorbs stocks from across the value-growth spectrum, but its rebalancing discipline pushes it into the small-value Morningstar Category. At each December rebalance, the fund effectively doubles down on stocks with valuations that have declined relative to their dividends. This contrarian approach leads the fund to cling to some losers and prematurely walk away from some winners, but it generally identifies good values and should bode well for performance in the long run.

This fund screens out firms whose composite quality and momentum characteristics rank in the small-cap market’s worst decile. This filters out some of the market’s riskiest stocks and helps the fund avoid some falling knives. Sector- and holding-level constraints help it avoid concentration risk. The 10 largest holdings represented 12% of the portfolio as of April 2021, and financials stocks’ 26% share of the portfolio marked the largest sector position.

The fund prioritizes quality but has still managed to deliver solid yield. On average its yield has been 40% greater than the Russell 2000 Value Index’s, its category benchmark, over the past five years. The fund’s new quality and momentum features may reduce yield a bit, but that’s a worthy trade-off for long-term investors.

This fund edged out the Russell 2000 Value Index by 3 basis points annually over the trailing 10 years through April 2021. It was a hot-and-cold decade for the fund. Favorable exposure to energy and industrial stocks made this fund the second-best performer in the small-value category from March 2012 through June 2016. It has cooled off recently, though; the fund ranked in the bottom 3% of all small-value funds over the 18 months through April 2021.

This fund thrived in the mid-2010s, thanks in large part to timely trades in the energy and industrial space. Printing and communications firm R.R. Donnelly & Sons RRD was the largest contributor. The fund added it to the portfolio in December 2012, after the stock had lost more than 31% year-to-date

By the time the fund sold the stock at the following year’s rebalance, it had climbed 117%. Surely investors should not expect these trades to come around often, but this exemplifies the benefit of backing stocks that appear cheap relative to their dividends. This fund has struggled more recently. 

It has held on to stocks like CSG Systems International CSGS and Strategic Education STRA as their returns have stalled out over the past few years. While the composite factor score should help identify firms that are justifiably cheap moving forward, this fund will inevitably stick to some losing stocks for too long. Full replication has helped this fund effectively track its benchmark. Over the trailing five years through April 2021, it lagged its bogy by 39 basis points annually, which is just a shade more than the fund’s 0.38% fee.

Source: Morningstar

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iShares Edge MSCI Multifactor Intl ETF

The strategy applies several constraints that promote diversification. It keeps country and sector weightings close to those in the MSCI World ex USA Index so that it doesn’t make large bets on segments of the market that may not be rewarded. The weight of each stock is kept within 2% of its weight in the index to prevent large positions in a single name. The strategy also limits turnover at each semiannual rebalance to 20%, which helps mitigate trading costs.

The optimizer also attempts to match the portfolio’s expected risk to that of the MSCI World ex USA Index. This should reduce the fund’s exposure to a given factor as it becomes riskier and prevent the fund from making big bets on risky styles. But the optimizer still lacks transparency, making it difficult to forecast what the portfolio will look like.

The strategy has paid off over short periods. However, it lagged the MSCI All Country World Index ex USA by 19 basis points annually from its launch in April 2015 through April 2021. Its 0.30% expense ratio also gives it a long-term advantage.

Process

BlackRock’s portfolio managers use full replication to track the MSCI World ex USA Diversified MultipleFactor Index. This strategy calculates a composite score for each stock in the MSCI World ex USA Index based on its exposure to four investment factors: value, momentum, quality, and small size. It uses an optimizer to select and weight stocks based on these composite scores, attempting to maximize its exposure to stocks with high scores while also satisfying several constraints. Among these, it tries to match the portfolio’s risk to the forecast risk of the MSCI World ex USA Index using the risk of each individual stock and their relationship to one another. The strategy also constrains country and sector weights to land within 5% of their weight in the parent index, while individual stocks must stay within a 2% threshold of their index weight to promote diversification. It limits turnover to 20% at each semiannual review to keep trading costs in check. The index reconstitutes semiannually in May and November.

The portfolio’s return on invested capital (a proxy for quality) is mildly higher than the index. Its emphasis on high-quality, profitable stocks isn’t very strong because stocks trading at lower valuations tend to be less profitable. Its exposure to names with positive momentum has come and gone. The portfolio emphasized high-momentum stocks between mid-2015 and mid-2016, and then again between mid-2017 and mid-2018.

The strategy’s country, sector, and stock constraints promote diversification. Stocks from eurozone countries and Japan represent 21% of the fund each. The industrials sector is the fund’s largest, at 21% of the portfolio, which is a few percentage points higher than its weight in the index. It makes up the difference by underweighting financials firms. The fund also diversifies stock-specific risks. Its 10 largest names represent 22% of its assets.

Source: Morningstar     

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Schwab International Small-Cap EQ ETF

Schwab’s portfolio managers use near full replication to track the FTSE Developed Small Cap ex US Index. The fund holds small-cap stocks from more than 20 developed markets outside of the United States, including Canada and South Korea, and weights them by market capitalization. This approach helps mitigate turnover and the associated trading costs, and it reflects the market’s collective wisdom about the relative value of each holding.

The portfolio effectively diversifies stock-specific risk, with only 4% of assets in its 10 largest holdings. Small-cap companies also derive more of their revenue from their local economy than large-cap firms. So, they can help diversify a large-cap portfolio. The portfolio excludes stocks from emerging markets, but a typical competitor only has a 5% stake in stocks from these regions. So, this difference shouldn’t affect its Morningstar Category-relative performance. It has a heavier stake in Canadian stocks than many of its competitors. This is noteworthy because the Canadian market is skewed toward risky companies from the materials and energy sectors, which can add to the fund’s risk.

The Fund Manager’s Approach

This fund tracks a well-diversified, market-cap-weighted portfolio that mitigates stock-specific risk and harnesses the market’s collective wisdom, earning an Above Average Process Pillar rating.

Schwab’s portfolio managers near fully replicate the FTSE Developed Small Cap ex US Liquid Index. This bogy starts with all stocks from more than 20 developed-markets countries outside of the U.S., including Canada and South Korea. It ranks them by full market capitalization and targets those that land between the 86th and 98th percentiles. The index applies buffer rules around these cut-offs to help curb turnover, and it uses additional liquidity screens that can make the index easier to track. The index weights its final holdings by their float-adjusted market cap. FTSE rebalances the index semi-annually in March and September. The managers may not hold every stock in the index because some names are more difficult and expensive to trade.

The Funds Portfolio

The resulting portfolio is well-diversified and reasonably represents the foreign small-cap market. Its broad reach encompasses more than 2,000 stocks. Those listed in Japan, the eurozone, and Canada each account for about 19% of the portfolio. This fund doesn’t take any measures to hedge its foreign exchange risk, so it has exposure to currencies like the yen, euro, and Canadian dollar. Changes in the exchange rate between these currencies and the U.S. dollar can add to the fund’s volatility.

The portfolio’s allocation to Canadian stocks is more than 3 times the category norm. This is noteworthy because the Canadian market is skewed toward volatile companies from the materials and energy sectors, so having a higher-than-average allocation to Canadian stocks has pushed the portfolio toward these segments of the market. Poor performance from these sectors over the past decade has reduced their weighting in the portfolio. As of April 2021, its allocation to these sectors was similar to the category average.

The fund is more focused on small-cap firms than many of its competitors, so its average market cap has been much lower than the category average. Smaller firms derive a large portion of their business from local markets, which improves their diversification potential.

The Funds’ Performance

This fund’s category-relative performance over the 10 years through April 2021 was closely tied to its sector composition. Historically, it was overweight volatile stocks from the materials and energy sectors compared with the category average. Declining commodity prices led to poor performance for these companies between May 2011 and April 2017, translating into poor performance for the portfolio. It underperformed the category average by 1.1 percentage points per year between May 2011 and April 2021.

Lacklustre performance from energy and materials-related stocks means that the fund’s allocation to these companies has declined. Its sector composition is now in line with the category average, and its performance over the most recent three years through April 2021 was almost identical to the average of its peers.

Source: Morningstar

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iShares MSCI EAFE Small-Cap ETF

It weights its holdings by market cap, an approach that benefits investors by capturing the market’s consensus opinion of each stock’s value while mitigating turnover. Markets usually get long-term prices correct, but they occasionally make mistakes. Investors can drive valuations up if they get excited about a particular area of the market, and market-cap-weighting will increase the fund’s exposure to it. BlackRock’s portfolio managers near fully replicate the index. They may exclude some names from the portfolio that are expensive to trade, which allows the fund to track its benchmark without incurring excessive trading costs. This is one of the most diversified portfolios in its category. It holds about 2,300 names, and its 10 largest positions represent only 3% of assets. The portfolio’s composition looks a lot like the average of its category peers, with comparable sector and country weights. It excludes stocks listed in emerging markets, while a typical competitor has a small 5% stake in firms from these regions.

The fund’s relatively low fee has helped it outperform many of its category peers. Its total return landed just inside the top quintile of the category, while its volatility was comparable. BlackRock charges 0.40% for this fund. This fee is fairly cheap within the category and should continue to provide an advantage.

This process creates a well-diversified portfolio that reasonably represents the average fund in the foreign small/mid-blend category. Its broad reach encompasses roughly 2,300 stocks. Those listed in Japan account for 28% of the portfolio, while stocks from euro zone countries and the United Kingdom represent another 22% and 18%, respectively. This fund doesn’t take any measures to hedge its foreign-exchange risk, so it has exposure to currencies like the yen, euro, and pound. Changes in the exchange rate between these currencies and the U.S. dollar can add to the fund’s volatility.

Other characteristics of the fund also look similar to the average of its peers. Industrials firms represent its largest sector allocation, accounting for 24% of the portfolio and category average. Its price/book ratio and return on invested capital both land near the category’s midpoint. They are a few differences between this fund and the category norm, but they are small and should not affect its category-relative performance. The portfolio does not include stocks from emerging markets, while a typical competitor has a small 5% stake. Historically, the fund’s average market cap has been lower than many of its competitors, indicating that it has a greater focus on the small-cap segment of the market.

Performance

This fund’s strong category-relative performance over the trailing 10 years through April 2021 was largely driven by its relatively low fee. It outperformed the category average by 1.4 percentage points annually over this decade in part because it charged about 80 basis points less than a typical competitor. And its outperformance has been consistent, beating the average of its peers in the foreign small/mid-blend category in nine of the 13 calendar years between 2008 and 2020.

This portfolio’s risk has also been on par with many of its competitors. Over the trailing 10 years through April 2021, its standard deviation was slightly higher than the category average, while its average drawdown was comparable.

Historical tracking error has not been exceptional. Over most of the fund’s life, BlackRock’s portfolio managers used a sampling strategy to replicate the index’s performance. This approach sacrificed some tracking error for lower trading costs. But the costs of trading these markets have become more manageable, so the team near fully replicates the portfolio, which should lead to lower tracking error.

Source:MorningStar

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Improved Outlook for OGE’s Midstream Investment

The increase in our fair value estimate was due in large part to the improved outlook for OGE’s investment in Enable. On Feb. 17, Enable announced it would merge with Energy Transfer. Since the announcement, Energy Transfer common units have risen almost 40% driven by an improved commodity outlook and Energy Transfer’s recently announced $2.4 billion pretax gain from the winter storm in Texas.

OGE management reaffirmed its intent to exit the midstream investment over time. With the strong performance of Energy Transfer’s common units, we assume OGE will divest its investment in Energy Transfer by 2021 year-end for aftertax proceeds exceeding $500 million.

Underlying utility performance in the first quarter was solid, although earnings were lower than last year. The primary driver of the weak first-quarter results was a loss from the guaranteed flat bill program during the February extreme cold weather event. OGE has outlined a cost-saving plan that we estimate will result in 2021 utility operating EPS of $1.80, near the middle of the original guidance range of $1.76-$1.86.

We have a high level of confidence that the additional $930 million of fuel and purchased power costs that was recorded as a regulatory asset on the balance sheet will be financed with securitized long-term debt. In April, both Oklahoma and Arkansas passed legislation allowing for securitization financing of these costs. We expect both transactions will close before year-end.

Profile

OGE Energy is a holding company for Oklahoma Gas & Electric, a regulated utility offering electricity generation, transmission, and distribution to more than 800,000 customers in Oklahoma and western Arkansas. OGE Energy also owns a 25.5% limited partner interest and a 50% general partner interest in Enable Midstream Partners, a midstream services business that provides gathering, processing, transporting, and storing of natural gas. In February 2021, Enable announced it would merge with Energy Transfer.

Source: Morningstar     

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iShares ESG Aware MSCI USA ETF

The fund tracks the MSCI USA Extended ESG Focus Index, which strikes a balance between ESG integration and broad diversification. The fund’s benchmark applies basic exclusionary criteria to the MSCI USA index to filter out companies involved in controversial business lines or severe controversies. From there, it employs an optimizer to lean towards companies with high ESG scores while managing against a 0.5% target tracking error against the MSCI USA. The index doesn’t stray far from its parent. Sector weights must remain within 5% of the parent index, and individual holdings can’t vary more than 2% from this starting point. The resulting portfolio has a very similar makeup to the starting universe and the category average.

As of March 2021, the fund’s active share relative to its parent index was just below 20%, which is fairly low compared with other ESG-intentional peers. Its top holdings are very similar to those in the parent index. This should help keep performance in line with the latter. That said, its relatively light-touch ESG exclusions mean that the index can include companies that might not have best-in-class ESG practices and might not be desirable for all investors looking for an ESG-intentional portfolio.

The fund charges a 0.15% expense ratio, which is competitive compared with its category peers. This low fee and low cash drag helped it outperform the category average from its 2016 inception through March 2021. Its ESG-driven bets have helped it this far, though this might not always be the case.

The portfolio management team fully replicates the MSCI USA Extended ESG Focus Index. Companies involved in severe controversies or controversial businesses such as tobacco, fossil fuels, controversial weapons, and civilian firearms are not eligible for inclusion in the portfolio. After filtering out those stocks, the index then uses an optimizer on the universe of eligible stocks to systematically overweight companies with high ESG scores. The optimizer targets tracking error of 0.5% relative to the MSCI USA index and incorporates other weighting and turnover constraints. Sector weights cannot deviate more than 5% from the MSCI USA index, and annual turnover is capped at 30%. The optimizer also determines constituents’ weights, though individual holdings must stay within +/-2% of their weight in the parent index. The 0.1% minimum holding weight means the index excludes many smaller positions from the MSCI USA index, but the two indexes’ holdings have significant overlap. Even though the portfolio is narrower and not directly market-cap-weighted, it closely resembles the MSCI USA index and, by extension, the category average.

As of March 2021, the fund’s active share against the MSCI USA was just 20%, as most of its exclusions are smaller names. As the top holdings in both indexes overlap significantly, the fund’s performance will be in line with the broader market over the long term–its 0.5% tracking error target will help ensure that is the case. Despite less than aggressive ESG tilts, the strategy’s ESG focus still enhances its profitability metrics compared with the MSCI USA index and land close to the category average. The fund’s exposure to firms with either narrow or wide Morningstar Economic Moat Ratings is also comparable to the category average.

However, as its position weights are tethered to the market-cap-weighted MSCI USA index, concentration risk can seep into the portfolio. Nonetheless, as it does not sacrifice much of the wide market scope of its parent index, it will retain most of the benefits of a typical broad, market-capweighted index portfolio. As of March 2021, the portfolio was well-diversified, with only 25.5% of its assets invested in its top 10 holdings, well below the category average.

From its 2016 inception through March 2021, the fund outperformed the category average by 3.09 percentage points annualized. Most of this outperformance can be attributed to favorable sector exposures. It has also been overweight certain top-performing stocks like Alphabet GOOGL and light on underperformers like General Electrics GE. Also, its ESG mandate has helped it steer clear of some troubled names such as Wells Fargo WFC. But these ESG-driven bets might not always pay out. The fund also outperformed the MSCI USA index by 41 basis points annualized over the same period. Its ESG selection criteria helped it to avoid a few losing positions included in its parent index and left it relatively overweight winners in financials and utilities. It has also weathered downturns better than the parent index.

The fund can sometimes be more volatile than the category average, but it tends to perform better when the market rallies. From its inception in 2016 through March 2021, it captured 106% of the category average’s upside and 103% of its downside. During the early 2020 coronavirus shock from Feb. 19 to March 23, the fund fell slightly less than the category average, outperforming by a mere 18 basis points. However, it outpaced the category average by 6.54 percentage points from the start of market’s rebound in late March 2020 through March 2021. The fund trailed the MSCI USA Extended ESG Focus Index by an amount approximating its annual expense ratio since its inception.

Source: Morningstar     

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ETFs ETFs

Antipodes Global Shares ETF

Jacob Mitchell is the founder and architect of this strategy, and is an investor we hold in high regard. Performance challenges in 2019 caused some concern around the contribution from the sector portfolio managers, but pleasingly their hit rate has shown improvement since that time. This is an area we continue to monitor. This exchange-traded fund charges a management fee of 1.1% plus 15% of any outperformance of the MSCI All Country World Net Index in Australian dollars, which is above the peer median. Investors should also note trading costs, which can affect returns. Antipodes publishes an intraday indicative net asset value on its website to help with price discovery, but bid-ask spreads can widen materially in times of volatility, so caution needs to be exercised. Despite this, the fund is a sound option for value-leaning investors.

Antipodes’ investment approach is centred on acquiring undervalued high-quality stocks to build a benchmark-agnostic high-conviction global equities portfolio. Antipodes’ analysts adopt a threepronged investment process to achieve this outcome, which involves quantitative filtering, intuition, and fundamental bottom-up qualitative research. Quantitative filtering is used to reduce the potentially huge investable universe of global stocks to a more manageable number. The metrics used to filter stocks include size, profitability, growth, yield, momentum, volatility, and value. The quant filters are also used to highlight region-sector valuation data, which provides the analysts with the necessary granular illustration of clustering for successful stock selection. Antipodes defines clustering as a collection of stocks that display similarities in operational, end-market, style, and macro characteristics. The next investment procedure involves analyst knowledge and comprehensive bottom-up research combined for the thorough assessment of a company’s business model, product offering, competitive advantage, stewardship, financial viability, and valuation. Analysts assess scale, business risks, cost position, midcycle earnings power, management integrity, and balance-sheet strength. Jacob Mitchell, who invests for absolute return, makes the final decision on stock selection.

AGX1’s portfolio is focused on three major objectives: capital preservation, inclusion of attractively priced stocks, and strong investment resilience (based on multiple opportunities for a stock to outperform). The team disregards index weights when creating its concentrated high-conviction portfolio, focussing on cyclical and structural factors. Almost 30% of funds under management is normally allocated to the top 10 stock holdings. Since inception, the portfolio has had a significant underweighting in North America (25%-35% exposure) and overweightings in Western Europe, developed Asia, and developing Asia/emerging markets (combined exposure of 50%-60%). This positioning is partly based on Antipodes’ structural view that favours the Chinese consumer and avoids segments of the US market, which are believed to be considerably overvalued (including many US high-growth technology stocks). Antipodes imposes a linked alpha factor (cluster) limit of 15% on the portfolio, together with using currency management to lower stock risk. A small allocation of FUM is invested in precious-metals stocks as further insurance against unforeseen events. Investors should be aware that the portfolio’s concentrated nature may result in heightened stock-, sector-, and geography-specific risks. Thus, we’d suggest limiting an allocation to a portion of an overall global equities exposure.

AGX1 was listed on the ASX in November 2018, although the underlying strategy, Antipodes Global (Long), was incepted in July 2015. Performance of this strategy through to 31 March 2021 has been mixed. After a strong start in 2016 and 2017, the strategy materially lagged the equity world largevalue Morningstar Category benchmark, the MSCI World ex Australia Net Return Index, over 2018 and 2019. This strategy doesn’t undertake stock shorting, unlike its Antipodes Global cousin, which has mostly been to its benefit. Indeed, Antipodes Global (Long) exceeded the category benchmark by a much wider margin in 2017, and despite underperforming by double digits in 2019 the result achieved was vastly better than the long-short version of the strategy. Stock selection in the Asian region drove the early results of this strategy–namely Chinese insurer Ping An Insurance and Korean electronics company Samsung Electronics. Antipodes also benefited from seeing value in Microsoft.

Source: Morningstar