Editors' Note: This is the transcript of the podcast we posted last week. Please note that due to time and audio constraints, transcription may not be perfect. We encourage you to listen to the podcast, embedded below, if you need any clarification. We hope you enjoy.
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Jonathan Liss [JL]: For reference purposes, this conversation is taking place on the Morning of Wednesday March 4, 2020.
My guest today is Salvatore J. Bruno. Sal is the Chief Investment Officer and Managing Director of IndexIQ ETFs, a New York Life Company, where his primary responsibilities involve developing and maintaining the firm's investment strategies.
Sal joined IndexIQ in 2007 from Deutsche Asset Management where he held a number of senior positions. He has a Bachelors of Science in Applied Economics and Business Management from Cornell and an MBA in Finance and Economics from the NYU Stern School of Business. He is a member of the NYSSA and the CFA Institute.
Welcome to the show Sal.
Sal Bruno [SB]: It’s great to be here. Thanks for having me.
JL: Yes, absolutely and I think considering everything going on in markets right now, the timing is pretty much perfect considering the strategies that IndexIQ offers in your specialization here.
SB: I think that’s right. I think, you know liquid alternatives have a definite role in a portfolio and I think that it has become even more clear given the events over the last several weeks.
JL: Yes, absolutely. And just to remind people because this won’t live for probably a couple of weeks, but we are speaking on March 4th so, last week the markets pretty much just took a line straight down as the coronavirus fears and spread of the virus and hit to productivity to the global economy could not be ignored anymore. That was followed by a 5% [downs] upwards on Monday and then the Fed just cut 50 basis points and the markets did not seem to like that very much. They were spooked by it. So, straight down and here we are up several percent again today. So, who knows what the case will be by the time people listen to this in a few weeks.
SB: That’s true.
JL: Yes. Okay, cool. So, your firm IndexIQ is best known I think for placing hedge fund style strategies into an ETF wrapper. In fact, your two largest ETFs really by far are the IQ Merger Arbitrage ETF (NYSEARCA:MNA), which has nearly a billion in assets under management, and the IQ Hedge Multi-Strategy Tracker (NYSEARCA:QAI), which also has close to a billion in AUM. And in fact, I think your firm really shies away from plain vanilla ETFs focusing instead on placing institutional strategies into ETF wrappers. Where does this focus come from exactly?
SB: So, that’s a great question. So, we have to answer that question, really have to go back to the origins of IndexIQ. IndexIQ started in 2006, I joined in 2007 to lead their Research and Product Development and there was a real focus on what we call democratizing alternatives. So, coming out of the TMT crisis, basically the meltdown in late 1999, 2000 time period, we saw hedge funds doing really well coming out of that period and then we also saw at the same time the rise of the ETF, and so the initial thought was can we put some of these hedge fund strategies together into the ETF wrapper in trying to deliver as much as we can of the benefits of alternative investments while trying to capture some of the benefits of the ETF wrapper namely improved transparency, liquidity, potentially lower fees, no performance fees and potentially tax efficiency as well.
And so that was kind of the first thing I set out to do work with IndexIQ is to try to develop some of these strategies and we took a couple of different approaches. The first was to capitalize on some of the academic research that was coming out around the 2005, 2006 period that looked at a concept called hedge fund replication that basically tries to identify the key factors that are driving the majority of the returns of a group of hedge fund managers within a particular strategy and see if you can replicate those exposures by owning other liquid instruments like other ETFs.
We built that out, we launched QAI as you mentioned came out in March of 2009 and that’s really designed to give you a broad hedge fund, the fund type experience give you very similar risk return profile similar co-relation patterns to the broad equity markets, but do so again by owning other ETFs instead of directly investing in hedge funds and thereby passing some of the issues that people had with the limited partner structure of hedge funds like lock-up, [indiscernible] higher fees, lack of transparency etcetera.
JL: Sure.
SB: The other approach we pioneered was a mechanical version of a Merger Arbitrage strategy, and we mentioned that one as well, MNA, and really just tried to codify a set of rules that identify which target companies we would buy, how much we would own of them, how long we would hold them, what would be the rules for getting them into and out of the fund, as well as how we would go about hedging some of the exposure embedded in that strategy. And those two have gone on to become our two largest and among our oldest ETF offerings.
JL: Yes, sure. And then, you've also rolled out a bunch of other products, I think along those lines, and we'll get into them. And I remember, I just – you know, again this going back a while, but your firm was the first one to launch currency hedged ETFs that were actually 50% hedged, which I think we can get into also why that makes more sense than taking a full hedge or no hedge at all. And, you know, when those initial hedged – currency hedged equity products came out, you know, they were touted as wow! This is amazing. It's a way to hedge your exposure, but realistically you were just taking the opposite of that of owning something 100% in dollars.
So, you know, again, well, we can get into that also. Before we do though, just to understand how IndexIQ is defining alternatives exactly. It's one of these terms that can often be somewhat of a catch-all, people use it in many different ways. How do you define it at IndexIQ?
SB: We definealternativesto be generally hedge fund type strategy that are designed to help provide diversification and reduce some of the downside participation that you would have in a typical equity or fixed income portfolio. And so, we’re looking for strategies that have differentiated sources of returns and risks that can be meaningful additions to an overall diversified portfolio. Merger ARB is again is a great example of that. It's returns are driven primarily by the premiums we collect on these deals when they actually complete, as well as the completion rate, which to a large extent tend not to be driven by broad macro events like things that affect equity markets and/or fixed income markets.
So as a consequence, it actually has a very low correlation to the equity markets, actually its slightly negative correlation to the fixed income markets. And so, adding something like that to the portfolio – it certainly has its own risks, but adding that to the portfolio as a diversified risk stream to your portfolio, which can reduce your overall portfolio volatility. So that's really how we're thinking about alternatives really more in the – what can we add to the overall portfolio as a diversifier.
JL: Sure. And, you know, you're talking about looking at different betas, but not necessarily by looking at other things like, for example, real assets, you know, commodities, which are often thrown into the alternatives basket also.
SB: Yes. I mean, so we do have, you know, a commodity [indiscernible] actually uses equities to get exposure to the commodities. And I think you captured something early on, you know, an important point, we don't try to come out with simple beta, me too type product. We try to identify products that are in the marketplace either brand new ideas, pioneering new spaces like the liquid alternatives like MNA and QAI or identifying products that are in the market place where we think there might be a little bit better way to construct them and solve that problem.
So, you know, using equities to get some of the commodity exposure, eliminate some of the problems that some of the commodity or the futures based commodity ETFs we're having in terms of futures, role issues, contango, position limits from the CFTC, etcetera, so we tried to build it using equities to get the exposure making it a little bit more efficient. And then, also along those lines would be the 50% currency hedge. You talked a little bit about, you know, we came out of those in 2015 and if you look at where the flows were there was a lot of money going into the 100% hedged in the 2014 time period...
JL: Yes.
SB: …which was basically right at the end of the move in dollar strength, and then, the dollar started to weaken, but a lot of that money was already invested in the dollar hedge, so the actual end user experience wasn't very good. We thought it'd be better to, instead of going all the way into currency hedge or all the way out to take a 50%, we call the hedge least regret. So it's just another example of our philosophy to try to identify what are some of the products out there and are there potential improvements we can make on those.
JL: Yes, sure. So in terms of alternatives, and then in terms of liquid alternatives, which I know there's been a real focus on add IndexIQ. What makes an alternative liquid specifically? And then, you guys had commissioned a study on this by Greenwich Associates, so what were some of the studies, findings and conclusions in terms of liquid alternatives?
SB: Yes, we did a partnership with Greenwich Associates in 2019 to look at the liquid alternatives landscape as it applies primarily to the institutional marketplace because we think institutions tend to be some of the leaders in terms of developing investment strategies and often where they go, others will follow. And so, we focused on that and we talked to endowments, foundations – we had Greenwich talk to endowments, foundations, family offices, etcetera, public plans, private plans, and what they found was really interesting is that if you look at the overall use of alternatives, it's very large. It's somewhere in the order of magnitude of about $5 trillion in terms of the institutional portfolios.
When you get down to liquid alternatives, it was a much smaller piece than that; it’s a little bit less than $1 trillion, maybe $800 billion to $900 billion. Then when we got down to the ETF portion, it was significantly smaller. It was somewhere in the $45 billion to $50 billion range. And so, what we found – one of the conclusions was we know that alternatives are important to institutions for a lot of the reasons we talked about earlier. Liquidity is important and if you look at, you know, trying to make sure that they are able to get their money out or be able to allocate capital or make capital calls, but the ETF landscape has not really participated in as a bigger way as it potentially could. And so, we think that as investors get more comfortable with some of the mechanisms of ETFs, I mean it's an adoption process, right.
First you had institutional investors using ETFs, we're not using them at all. Then they started to get using them a little bit on the margin dipping their toes, and then they got very comfortable and they used some of the largest, most liquid simple beta ETFs in large numbers now. We think that evolution of life is going to continue, so the Greenwich Associates survey basically calls for roughly a doubling of assets over the next 12 months and that would be their forecast. So, we think as people get more comfortable, as ETFs pass some of the tests, I think one of the concerns has been will the ETFs offer liquidity, but do they really offer liquidity when you need in times of stress?
I think we talked about the last couple of weeks and the market gyrations in response to the coronavirus and if we could have ETFs, in general, have traded, they've traded very orderly across the board across pretty much all the ETFs. And then, we looked at how our ETFs have traded in the liquid alternative space, and they've actually traded very liquid as well. So, I think, you know, this is kind of one of those opportunities where I think the liquid alternative ETFs have had an opportunity to address some of the questions that people had in terms of will there be liquidity when I really need it? And I think that they've passed that test over the last couple of weeks.
JL: Yes, sure. No question about it. And I mean for me, just – when I started following markets, working at Seeking Alpha back in 2006 and getting into ETFs, so just seeing the way that exchange traded funds behaved in late 2008 and early 2009 kind of sealed the deal for me in terms of, you know, if ETFs can remain liquid and orderly and not, you know, go totally off the rails in terms of the second-by-second trading and iNAVs during disruptions like that, then it's hard to imagine when they wouldn't behave properly.
SB: I think that's right. And I think, you know, if you look at the assets then versus where they are now, they're probably a factor of [four].
JL: Yes.
SB: And so, there are a lot more eyeballs on it now and I think that you're right. I think the ETFs generally passed the test in 2008. Our ETFs were not out, so I think people had questions on liquid alternative ETFs because they hadn't really been tested during that time period, and I think you just have so many more assets invested in ETFs and generally speaking, and you look at the percentage of volume that ETFs take up in the market these – during these periods of crisis and it really goes up. I think people have used them as a source of liquidity and I think that they have really answered the call for that.
JL: Yes, sure. No question about it. Okay, I'd love to get into the use of liquid alts in portfolios here for a bit. So, you have a classic 60/40 stock bond portfolio, and of course, that kind of a portfolio is sans alternatives. You really just have two main betas in it, equities and fixed income, and, you know, you can have different kinds of betas within those asset classes, but the correlations are relatively similar. Why is it that that every properly diversified portfolio should have at least some allocation to alternatives in it?
SB: Because – I mean, I think what you're looking for when you're adding alternatives, again, getting back to that Merger Arbitrage example, you're looking for a strategy that has a different set of drivers of risk and return than you would get from a traditional equity or a fixed income portfolio. And so, by bending on things like having exposure to deal premiums, deal completion rates, again, those tend to be somewhat immune at least over the short run to short-term market moves to interest rate moves. And in fact, if you look at the relationship between Merger Arbitrage returns and interest rates, Merger ARB returns tend to go up during periods of rising rates because basically you’re trying to get a premium over the risk free rates.
So, as rates start to go up, Merger ARB returns tend to go up, which means that they actually have a negative correlation. Merger ARB returns are somewhat slightly negatively correlated to bond – to the bond market, which is actually really diversifying for the portfolio. So, what I like about these liquid alternatives is they are not necessarily best against the market, which is one way to hedge your portfolio, and you can take short positions and you can use inverse product, but you're really taking a directional bet there that the market is going to move in a certain direction. If it goes down, then you do well. What we’re trying to do is to introduce strategies that have their own positive expected returns.
They have a positive – they have an expected return driver, right, against the deals getting completed and collecting the remaining premium, but you want those – that premium, that deal risk to actually be diversifying to the rest of the portfolio. And so, I think that's why liquid alts make a lot of sense even in a 60/40 portfolio, and really that's been a really good portfolio as the S&P 500 has recovered so well from the depths of the great financial crisis, and bonds, generally speaking, have been almost in a 40-year bull markets and it’s kind of peaking in 1981 in terms of interest rates. So, …
JL: Yes.
SB: …that's been a really good portfolio, but we think even within that simple 60/40 mix, there is room for strategies that have a different return driver.
JL: It makes a lot of sense. And so, last week, GMO’s Rick Freeman put out a piece titled 60:40 portfolios face double trouble ahead in which he essentially argues that because stock and bond valuations are both extended and that valuations will have to drop with both of them, his suggestion is that liquid alts actually have a strong place in portfolios right now. So, just curious, and of course, this is going to differ by somebody's strategy and ability to take on risk, but does the allocation to liquid alts – do you think that that is something that should change over time, for example, in very volatile market environments? Should an investor be increasing their general allocation to liquid alts? Generally speaking, to get the diversification effect, what percent of the portfolio needs to be in liquid alts? And then, how would you be changing that up depending on market conditions?
SB: So, I think I agree with a lot of what he says there. I think, you know, part of what we've seen though is because equity markets have been almost going straight upwards for over 10 years now, I think people have gotten maybe a little bit complacent and because fixed income has actually done well, I think there's maybe – and you talked about the stretch valuation on both of those, I think people have said, well, you know, I don't really need alts because I'm kind of okay. We think that people should have some sort of a based allocation to alternatives because as we've seen all the events in the last few weeks, the market moves can be pretty swift and trying to put these types of strategies in place after the markets already started to move, I think it can be actually very difficult and that they do miss a lot of the benefit of having them if you don't have them in place ahead of time.
JL: Yes.
SB: So, we think that investors should have kind of an evergreen allocation maybe around 10% or so depending on the individual circumstance, that’s very dependent, it’s a very rough number.
JL: Yes, sure. No, nothing here is a recommendation for any specific individual. Of course, these are always going to be ballpark just like the 60/40 portfolios, obviously, not a recommendation for any [individual] person.
SB: Right.And so, if you look at what the allocations offer institutions, a lot of pension plans are around 20% or so. You know obviously, we think that that's a reasonable number given where the current allocation is and many portfolios are significantly less than that. So, as a first starting point, we would say, you know, at least maybe 10%, but looking at where some of the big pension plans are, they’re definitely even more than that, and we think that's important to have a based allocation, and I think during periods of stress, I think that's when you may want to start ratcheting that up even higher to provide some of the diversification that you need in that portfolio and limit some of that downside participation.
JL: In terms of the specific strategies that you offer, you know, I'd love to just get into a few of them briefly. So, if you could just kind of, on a basic level, just take listeners through what the overarching objective of some of these strategies are starting with the IQ Hedge Event-Driven Tracker ETF, (QED), what does that mean exactly, Event-Driven Tracker?
SB: Yes. So, if you look at (QAI), just thinking back to our broad hedge fund replication type approach, that's made of six individual hedge fund strategies. One of them is event driven. It's a multi-strat event driven. And so, what we do is we replicate each of those strategies individually. For QAI, we rolled them all up into the multi-strategy, but for some of these – for those six strategies that are – we make them available individually, so our event-driven is basically like the event driven sleeve of QAI.
So, it's really trying to replicate the returns of event driven managers by looking at what are their systematic beta exposures to different asset classes or sub asset classes and what we find for event driven, again when you look across the group of managers, and the key here is that individual manager best tend to diversify away just like a portfolio would when you put a bunch of them together. And so, we're not trying to capture individual deals or individual name exposures with our event driven, it's really more of what we see is moves across the capital structure, which is what a lot of event driven is about.
It's two companies combining through a Merger ARB. It might be a stock for debt or a debt for stock or some other corporate event that changes the capital structure, and those moves can somewhat be [proxied] by exposure to asset classes that represent different parts of the capital structure. So, it might be convertible bonds or the debt to stock, it might be some stock ETFs, it might be some corporate bond ETFs. So, putting all of them together, we try to put them together in a way that gives you a return profile. Again, it's very similar to the average event-driven hedge fund that's out there.
JL: Okay, so next up you have a macro tracker ETF, which is ticker symbol (MCRO), what's the basic strategy there?
SB: Again, it’s just one of the sub-strategies of QAI. There’s actually two sub strategies. We take our emerging market hedge and our global macro hedge and we put them together to make our macro ETF, so sort of EM tilted macro strategy. And again, the basic principle is if you look at a group of EM or emerging market hedge fund managers, they'll have exposure to things like emerging stocks, bonds, commodities, currencies, large cap, small cap in the EM space, so trying to capture some of those systematic exposures through ETFs, again, not trying to get individual names, we're trying to get those diversify away from trying to capture those systematic strategies.
Similarly, when we look at global macro, which you need to cast the net in terms of your factor exposures, a lot water because global macro managers basically go anywhere and do anything, so that has probably the broadest set of factors that we're looking at, and it really runs the range across almost all of the different asset classes between stocks and bonds, commodities, currencies, volatility, which show up in a strategy like that. And so, it has a very broad set of factors and we proxy those again through ETFs.
JL: Sure. How are you running these indexes exactly though?
SB: So what we do is we take the returns of a group of hedge fund managers and we identify using some statistical measures what are the most important factors that are driving those returns, and then, we basically take those factors and use other ETFs to get those exposures. So, we're trying to say these are the important factors. I walked through kind of an example of the emerging market hedge where it's emerging equities, large and small cap, emerging debt, US dollars dominated local currency, commodities, currencies, etcetera.
And so, when we take the returns of these hedge funds and we say these are the important factors, and then, we estimate what the exposures are to those particular factors for the emerging market strategy, and we construct an index that's made up of those ETFs that represent those factors in the way that are derived from the model.
JL: Sure. And I mean I assume when hedge funds run these strategies though, there are some manager discretion in terms of weightings and allocations and all of that, so how do you end up with that in some kind of an indexed formula?
SB: So, if you look at it, we're looking at the group of returns – the returns of a group of managers. And so, just like you [indiscernible] in a portfolio, if you were to put together a whole group of managers, a lot of those individual managers picks and diversify away and they also tend someone to offset each other. So one manager, you know, you may see in their return pattern for an individual manager that they're [overweight] large cap versus small cap and that kind of shows up in how their particular hedge fund returns performed in different environments or as large cap moves versus small cap moves.
And when you put them all together, you can actually look at the return profile of that group of emerging market managers and identify and say, okay, they have a certain exposure, an estimated exposure to large cap and an estimated exposure to small cap and to emerging market bonds, both local currency and dollar currency, etcetera. And so, when we run our models, that would give us what the exposures are to emerging large cap, emerging small cap, and so, then we construct the index basically to reflect the exposures embedded in those return series.
JL: Sure. Makes sense. And then, in terms of a couple of other ones I was curious about, so the IQ Hedge Long/Short Tracker ETF, (QLS), is that actually shorting underlying ETFs to balance things out or what – what's the approach there?
SB: So for long/short, if you think about how the average long/short manager is building their hedge fund, they're going to have some long positions. They'll have some short positions. They tend not to be net short.
JL: It's like a 130/30 type strategy, right, that sort of thing?
SB: Exactly. So their exposure, their beta to the market generally tends to run somewhere between 0.3 and 0.7. They tend not to go even close to zero or net negative. And so, if you look at our structures, it's very similar to that as well. So, we'll have some long positions in some factor based ETFs. So, you may be, you know, overweight growth and underweight value, so you might see a long position in growth ETFs and growth equity ETFs, and a short position in value-oriented ETFs to try to mimic some of those factor exposures that are going on.
Again, the individual names, whether they're long company A and short company B, that doesn't matter as much when you look at a group of managers. What you want to capture is, are they making systematic calls on different sectors? So, we'll have sector ETFs to represent those. Are they making calls on different factors? We'll have factor-based ETFs to represent those. And again, if you look at the return patterns of that group of long/short managers, you can estimate out what their exposure is to those factors at different points in time. We have ETFs to represent those factors and we build the index that way.
JL: Sure. And how are you selecting the underlying ETFs like at this point, there's close to 2,500 ETFs listed on the major U.S. exchanges? For example, if you're looking at sectors, you have many different directions you could go, BlackRock (BLK), State Street (STT) and Fidelity. What – how are you making those determinations of which funds to actually hold to approach these strategies?
SB: Well, we want to make sure that our ETFs that we offer are as liquid as possible, and as you're well aware, the liquidity of an ETF is derived from the liquidity of its underlying holdings.
JL: Right.
SB: So, we want to make sure that the underlying ETFS that we're owning are as large as possible so we can get positions in them; they’re liquid as possible and we look at what their fees are because we want to keep the embedded cost as low as possible.
JL: Sure.
SB: And then, we also – so what we do is we filter down all 2,500 or so names down to a universe of approximately 150 unique ETFs that basically represent kind of the asset class exposures we might want to consider. As you know, there are multiple ETFs to have that give you similar exposure to things like international equity. They're multiple ETFs to the S&P 500. We basically take one of each of those categories for our modeling purposes. And so, when you do that, you get down to about 150 or so. And then, we go through a statistical process that looks at how similar or what are the factors that work best in terms of providing a return so that replicates a particular hedge fund return series, and we'll do a bunch of statistical analysis. We'll look at the correlation of those 150 ETFs to the different hedge fund strategies and stop there to see which ones we can select and put together that give us the best tracking to that hedge fund index.
JL: Sure. And you're staying consistent across index or I assume, right, so you're not like picking one MSCI and then a FTSE that way you're basically getting a full allocation for different kinds of rotations, correct?
SB: Well, so we'll use ETFs for multiple sponsors, but again, we try to use the largest, the oldest, the most liquid, the cheapest, and sometimes it's Vanguard and sometimes it's iShares and sometimes it's State Street, and sometimes it's for a little bit more narrow exposure. It might be one of the smaller issuers. So, you know, we'll maintain relationships with all of them to understand their strategies and which ones make the most sense for our particular strategy. One of the things we do though is once we select an exposure and say, it's international equity and we have a certain allocation to that, we will own multiple international equity ETFs from different providers.
So, we might own one from iShares; we might own one from Vanguard and one from State Street to get that exposure, and we'll split that allocation on a pro-rata basis depending upon the size of those ETFs so that each one is kind of proportional to their AUM within that particular asset allocation. So for example, if we wanted 10% exposure to international equity, you know, we might put 5% in an iShares product and 3% in Vanguard and 2% in a State Street product, so that's how they’re relative to assets [indiscernible] to each other.
JL: Interesting. And that would be the case even if they were trying different indexes. So for example, maybe one of them was including Canada and it's – you know and it's a developed coverage and another one may be left it out, you know, would that factor in or not really?
SB: Welook at similarities, you know, depending – sometimes they are following the same index and many times they are not. If they're following very similar indices and their correlations are very high and their patterns or returns are actually very similar, we would include multiple ETFs in that types of situation, but we do look for similarities and differences and if the differences are too large, then we would basically not include that particular one.
JL: Oh, okay. Very interesting. So, I'd love to move over to your 50% hedged products and particularly with some of the currency moves of late. I think this will be interesting to many listeners. So, you have three right now. You have (NYSEARCA:HFXI), which is FTSE International; (HFXE), which is FTSE Europe, and (HFXJ), which is FTSE Japan. So, if you wanted to just kind of walk listeners through the logic of why you came out with 50% hedged ETFs kind of the history of the initial hedged products, which were basically just a 100% hedged away from the dollar and then why you feel that your kind of hybrid approach, 50% hedging, which essentially just eliminates currency risk and just tracks the underlying equities, why that makes sense for U.S. investors?
SB: Yes. So, we came out with these products – these three in the middle of 2015 – in July of 2015, and they were really in response to – again, going back to our – the way we think about product development when we look for other opportunities to bring better strategies out.
JL: You're talking about WisdomTree (WETF), those massive inflows that they had in (DXJ)?
SB: Exactly. 2013, 2014, we saw a lot of money. The dollar was getting strong. There was a material impact to the return profile of international investments that were getting weaker because the dollar was strengthening. And so, we tried to tell clients it’s very important when you rise you’re investing internationally, you have to recognize that you have – you're making two allocation decisions. But first is you're allocating to the stocks and the local market, which is probably most people are thinking about when they make the allocation. But you also have to recognize that you are making an exposure or getting exposure to the currency in which those equities are denominated and that can have material impact on the volatility of your returns as well as the absolute level of the return.
And so, if you're investing locally and you're unhedged, you have to recognize I'm betting on the local market and I'm betting on that currency to appreciate. If you're hedging it a 100%, you're saying, I'm still betting on the local markets, but now I'm actually betting a 100% on the dollar appreciating and those local currencies depreciating. And what we have seen over time is, first of all, people are – most investors are not very good at making that currency call.
They may not even be aware they’re making it, and if they are, they may not be very good at timing it. And if you look at the dollar weighted returns of investors on the currency hedge versus the asset weighted, insignificantly low because most people tend to buy a little bit too late and they can't time them properly. So, after the dollar has already moved up, then they realize that they need the currency hedge and that's when they flow in and that's when the dollar inevitably reverts and goes the other way, and then, they sort of get whipsawed on it.
Our thought was, let's give them a simple down the middle solution where we keep all of the equity exposures. So, we partnered with FTSE Russell, it's a very straight forward equity – it’s a free-flow market cap adjusted equity weighted portfolio, right. So, it's a very plain vanilla equity sleeve; it gives you very similar exposure as you would from any of the other issuers or indices, but the key innovation is you only take a 50% currency hedge. And so, you're not really saying, I expect the dollar to get strong. I expect the dollar to get weak. What you're saying is, I'm not really sure. I'm going to go right down the middle.
So, you're never a 100% right. You never a 100% wrong either. We call it a hedge of least regret. And so, our philosophy – our thought process is we would rather be approximately correct because the right answer is probably somewhere in the 30% to 70% range in terms of how much you should hedge. So, you try to be approximately correct and be precisely wrong and try and get – try and call them one way or the other. So, we think it actually makes for a very attractive core position for some of your international or Europe or Japan exposure, and really the kind of the benefit that you get from it is potentially reduced volatility.
So, what we see in many cases is there's a positive correlation between the local market and the currency, alright. So, if you think back to the great financial crisis, the [indiscernible] all of that, you know, what we saw was the local markets go down and the euro go down, it goes down at the same time. So, I mean that they’re positively correlated. By taking some of that risk off the table, by hedging that, its currency exposure, you're reducing some of the exposure to a highly correlated asset that reduces overall portfolio volatility. And so, what we've seen is over the period that we've been [live] we've been able to reduce some of the volatility, especially related to currencies, which has actually improved the sharp ratio or the risk adjusted returns of those 50% currency hedged relative to the unhedged.
JL: Nice. And then, I guess final funds that I wanted to discuss here of yours is you have two Candriam ESG ETFs (NYSEARCA:IQSI) (NYSEARCA:IQSU). ESG has definitely been a big conversation of topic and as big topic of conversation and growing in popularity among U.S. investors. It's been popular in Europe for quite a while already, but definitely increasing in popularity in the U.S. also. And I was curious what exactly is the approach to ESG that you're deploying here? I know everybody kind of has different definitions and different screens for it. What is the IndexIQ Candriam approach here?
SB: So, we think that's a very unique and differentiated approach for a couple of reasons. The first is, IndexIQ being part of the New York Life Investments Organization, it means that we are part of a multi-boutique structure. Candriam is a well-known asset manager over in Europe, and they basically have been running, and they were also owned by New York Life Investments to one of our sister boutiques. They have been at the forefront really in terms of ESG and you mentioned how it's really taken foothold in Europe, lot earlier than it has in the United States. Candriam has been doing this for over 20 years, so there are really, no – they're not very new to the process.
They have a very rich history of doing a very well defined process that they have honed over the last 20 plus years and they run a significant amount of assets doing this over in Europe. We partnered with them to have them do the security selection of securities that meet their ESG criteria out of some very basic broad market cap weighted indices. So, we have the U.S. broad market cap index and it's developed international as well. On a quarterly basis, they applied their ESG criteria and select the names that meet their criteria out of those indices, and then, they become market cap weighted. So you – what you end up getting is – we also make sure that the sector weights and the country weights in the international are actually within plus or minus 5% of those boarder market cap weighted benchmarks. And again, they are market cap weighted in our portfolios.
So, you ended up getting – and we think they’re a pretty interesting core type holder and should have very low tracking to the base index, so it could be thought of as a core holding in your portfolio, but it's done leveraging the Candriam methodology. They're also at a very interesting price point, so the U.S. one is at nine basis points making it, at this time, the cheapest ESG offering in the US. The international is at 15 basis points, which I think makes it second and maybe one at 14 basis points, so it's among the cheapest. So, we think that using the Candriam methodology as well as the low – the price point and the core – the fact that it [indiscernible] core piece of the portfolio, we think makes them very attractive offerings.
JL: Sure. And the ticker symbol on those are IQSU for the U.S. one. I hadn't actually mentioned that earlier. And then, the second one, let me just pull up here.
SB: IQSI.
JL: IQSI, yes. I guess easy to remember the U for U.S. and the I for international.
SB: Yes. That's how we came up with that ticker.
JL: Nice. I like that. Anyway, Sal, I wanted to thank you for being so generous with your time today. It's been really great.
SB: Thanks for the opportunity. It was great speaking with you.
JL: Yes, sure. So, for people that want to research your funds further or read more about liquid alts and the other strategies you offer, you want to tell them where the best place online for them to go for that is?
SB: Yes. So, if you go to IQetfs.com, you can find all of our underlying indices and marketing collateral information on our funds.
JL: Nice.
SB: You can also follow us on LinkedIn and on Twitter. We post pretty regularly. I post pretty regularly there in terms of blogs, commentary on what's going on in the markets, as well as our monthly newsletter that kind of highlights what's going around our strategies.
JL: Amazing. And what's the handle on Twitter for people that want to look that up?
SB: @SalBruno_IQ, yes.
JL: Andthen, @IndexIQ ETFs is the other one?
SB: Yes.
JL: Anyway, Sal, thank you so much. Best of luck out there. Hopefully things won't get too crazy with the whole coronavirus thing and markets will stay calm and people will be able to stay calm because of some of the products that firms like IndexIQ are making available to them.
SB: Thanks. I appreciate the opportunity. It was great.
