Why active ETFs benefit you when the market is down | Karen Trau – Perpetual

Maddy: [00:00:20] Hello and welcome to your In Good Company, a podcast that makes investing accessible for everyone. I'm Maddy and as always, I'm in some very good company with my co-host, Sophie. Hello, Mads. How are we today? We are good. How are you? Okay, good. We were just having a bit of a laugh before we started recording about today. We're going to talk about ETFs on this episode, but we were laughing at that. We did over lockdown. We did seven days of lockdown or 7/8 for seven days of lockdown, like last year in the midst of like COVID winter. It was a dark time. I remember the issues we had with trying to record those. I know. Oh, my gosh. I remember we used to like a lot. We started going live or something and then one of us and my cousin got into the room and I was she got so excited and was freaking out. And then we tried to do a house party as well and we said Everyone got the notification bang. Like Maddy and Sophie have entered the room. And I think we ended up making like two new Instagram. Kev I think we, I think we ended up we ended up making two fake Instagram accounts just so that we could go live without any false. And they got through our seven nights of ETFs. You deserve a medal. Reach out to us. Get your prise. That is solid commitment. Anyway, we should jump into it then. Good segue, right? ETFs. Well, speaking of ACM, today's episode is brought to you by Perpetual. We are very fortunate to be welcoming Senior Product Manager Karen Trau to the show to discuss the fundamentals of active chefs and how we can use them in our investment portfolios. Perpetual is an ASX listed diversified financial services company, which has been servicing clients since 1886. They have four business divisions Perpetual Asset Management Australia, perpetual Asset Management International, perpetual private and perpetual corporate trust that aim to protect and grow their clients wealth. Karen, we are very excited to have you, so thank you so much for joining us today. 

Karen Trau: [00:02:22] Thanks for having me. 

Maddy: [00:02:23] Karen, we wanted to start out by getting to know you a little bit. So our first question is, what's the best thing that's happened to you this week? 

Karen Trau: [00:02:30] That probably is going to be my favourite question and we haven't even started the podcast. So it was actually my birthday two weeks ago and I'm actually still celebrating because I'm not really the type of person to have.

Maddy: [00:02:42] One big party. [00:02:42][0.6]

Karen Trau: [00:02:43] So I kind of use it as an excuse to catch up with all my friends at a nice restaurant over a glass of wine. So I spent Saturday at lunch with my high school friends, which was really nice, very nice. [00:02:53][10.7]

Maddy: [00:02:54] We love a birthday month. Celebrations continue, I say. Yeah, definitely. And I guess that could be relevant then. If you're going to have dinner with anyone, who would it be and why? [00:03:04][10.0]

Karen Trau: [00:03:04] So tennis has been on my mind lately. I'm quite the tennis fan, so I'm going to say Nadal. So Rafael Nadal from Spain and I've followed him since the start of his career and watching him win the 22nd Grand Slam at the Australian Open at the start of the year. He came back two sets down to love and it was probably one of the best matches I've seen and if I had dinner with him I would definitely ask him about his motivation, his tenacity and just how he trains physically and mentally. I just think more so than any other player, he just has an unbelievable endurance and fight that just makes him keep going despite all of his injuries and the other conditions that they face. So, yeah, Nadal called me. [00:03:50][45.2]

Maddy: [00:03:50] I don't know how I feel about this. I'm a massive Federer fan. Oh, no, we could oh, it could be we could have this conversation the. [00:03:57][7.1]

Karen Trau: [00:03:57] Whole night, I think. [00:03:58][0.6]

Maddy: [00:04:00] I also know that Netflix is coming out with a tennis series. I don't know what it's called yet because I don't think it's come out. But I wonder if it's going to give us any insight into all these players and how they think and feel. [00:04:10][10.2]

Karen Trau: [00:04:11] Oh, that would be really interesting to watch. [00:04:13][1.7]

Maddy: [00:04:13] Yeah. And Karen, final question of our beginning questions for you. If you could be a stock or company, who would you be and why? [00:04:21][7.3]

Karen Trau: [00:04:22] So I personally invest predominantly in ETFs rather than individual companies, so that just aligns more with my personal goal for investing, which is to build long term wealth. And ETFs are a great diversification tool. For that, I probably might need to borrow what can from ETF security said and say that I'll be an ETF and obviously a bit bias I would say Perpetual's active ETF so probably out ethical sorry if I did. So the ticker code is give give a say that invests in Australian ESG companies and it also intends to donate a portion of its performance fees to charity. [00:04:58][36.5]

Maddy: [00:04:59] I think that's. Really cool that they do that. Actually, I haven't heard about. I know we've we've talked about hearts and minds on the episode before and how they able to for GA I think therefore go the management fees to give it to charity but I've never heard of that so that's really cool. [00:05:14][15.3]

Karen Trau: [00:05:15] Yeah, definitely. [00:05:16][0.3]

Maddy: [00:05:17] So Karen, we are big fans of ETFs as a way to diversify our portfolio is a little bit like you just said it yourself, but keen to actually get into it a little bit more and understand what is an active ETF. And I guess how is that different from a passive investing strategy. [00:05:33][16.4]

Karen Trau: [00:05:34] If we take a step back? ETFs are really just an investment product that invests in a variety of assets. So cash, fixed income, Australian global shares, property, etc.. And so it's have traditionally been index tracking. So the fund manager will buy the stocks of securities that make up that index such as, you know, the ASX 200 or the Nasdaq 100 or the S&P 500 and the passive ETF. They seek to achieve a return that's in line or similar to their benchmark. And so if you're tracking the benchmark, then you don't have the discretion to change the stocks in your portfolio. So you have to hold what's in the index or a representative sample of that index. So hence you might hear that term passive investing. So if there's a stock in that index that's not performing so well, then you can't choose to divest out of it. On the other hand, you have activates, so they actively manage by a professional fund manager. So that means they're able to change the securities in and out of its portfolio at any time to adapt to the changing market conditions. So ETFs will normally have the investment objective to track the return of the benchmark activities would generally have an investment objective that seeks to outperform a benchmark over a certain period of time. So from a performance point of view, they can vary quite a bit. And so if I use Perpetual as an example where active managers, so we have a large investment team that scour the world for the best ideas. And that investment team has a strong focus on its generation and conducting research to find the stocks that are most attractive for the portfolio. And so what that normally results in is a portfolio that might include stocks in a particular index, or it might include more or less of a particular stock relative to the index. So you might hear the terms overweight or underweight, or it might be a combination of both. And so that's kind of the beauty of active management in my opinion, because you're not constrained to a particular index. So you can adapt that portfolio to changing conditions and you have more flexibility. [00:07:42][128.6]

Maddy: [00:07:43] Just given what you said that, you know, you do have a large team of people behind the scenes who are working out what you want to allocate towards this active ETF. Does that come with greater costs for the average retail investor? [00:07:57][13.4]

Karen Trau: [00:07:57] Yeah, that's a good question. And so if you do invest in ETFs or any managed funds for that matter, then a management fee will generally be deducted from your investment. And so that's charged by the fund manager who wants to manage your money, and they'll invest it in accordance with the investment strategy. And so sometimes fund managers might have a higher management fee or performance fee, and that's because they generally have an active investment approach. And so in exchange for the extra work, the ideas they generate, the research, the stock selection, the larger investment team, as you mentioned, they generally might have a higher fee in order to achieve those returns. [00:08:36][39.1]

Maddy: [00:08:37] No such thing as a free lunch. I know personally I have been thinking a lot about sustainable investing recently and trying to sort of align my portfolio I guess a little bit more with my values. But it can be quite hard, especially when things like greenwashing are so rampant to really understand is this company ethical, is this company sustainable? And I guess when you're talking about having a team of experts behind this ETF, you know, that is something that sounds to me like it could be a really attractive option in this space to make sure that I'm actually sort of really aligning my portfolio with my values. I'm interested to hear like what kind of screens does Perpetual have when it comes to, you know, you mentioned give before, they're one of the ETFs you have, what kind of screens you have when you're adding different companies to your ETFs? [00:09:25][47.5]

Karen Trau: [00:09:26] Yes, I'll use Give as an example and I'll carry that through. And so that fund's been around for over 20 years. And so that fund invests in 30 to 80 Australian ethically and socially responsible companies. And so we have a three step process to identify what stocks go into that portfolio. So the first one is based on Perpetual's full quality filters, and that applies to all of our Australian equity funds. So our investment philosophy is very much based around identifying companies of quality and. Are you? And so what does high quality mean? We look at four main things. So we look at the quality of the business. So we look at what industry the company operates in its market, share its barriers to entry, their products and their positioning in the market. And so often we look for companies that have monopolistic assets or their market leaders in their field. The second thing that we look for is conservative debt. So we scrutinise the balance sheet and we want to avoid overleveraged companies. So I would say that's probably more important now than ever, given where we are in the market cycle with, you know, rising interest rates, inflation and supply chain disruptions. But we want to make sure that the business and its balance sheet can support future growth. And then the third thing that we look for is sound management. So we conduct over a thousand company calls and meetings every year, and we want to meet the board, the management, the CEO to understand the culture, the business, the direction which they're heading in. We want to ensure that they are using shareholders capital sensibly and they have strong governance as well. And then the last thing we would look for is recurring earnings. So companies that have at least a three track record of generating cash flows and earnings. And so we research about 450 companies. And then after you apply those for quality filters, we're left with about 280. And then our second and third step is the HD screens. So we look at what a company does and then how they do it. So the first ESG screen is what a company does. So we look at its revenue. So if it derives its revenue from tobacco or armaments, then it's excluded. And then if it derives more than 5% of its revenue from fossil fuels gambling, alcohol, genetic engineering, pornography, animal cruelty, uranium and nuclear, then we also exclude it from the portfolio. And then the last step is our Responsible Investments team. So we have a dedicated team that looks at ESG and they look at how companies perform across various issues. So how does a company perform in areas such as the environment, labour standards, human rights, renewable energy, corporate misconduct, supply chain? Each companies then scored on this and then depending on the severity of the issue, the company could get a negative score and completely fail to screen or it could pass and then it's included in the portfolio. So that's how we kind of funnel through all of those stocks, avoid the greenwashing, and then result in what we believe is a high quality portfolio that can deliver long term capital growth. [00:12:45][199.5]

Maddy: [00:12:46] I actually kind of love hearing that because I think, you know, as a retail investors, maybe before I do and I have been looking for, you know, sustainable stocks, ETFs to buy into. But the research can be quite overwhelming sometimes, especially when you don't have all the time. So it does seem like, you know, having an active ETF available in your portfolio, it's like someone is behind the scenes doing all that research for you that is professional at doing this. [00:13:11][25.7]

Karen Trau: [00:13:13] Yeah. And I might just add some tips for our listeners. If you go to our website, perpetual dot com direct you give it actually explains our screening process that I mentioned in detail. And then it also has a portfolio impact measurement report. So that's got a lot of ESG attributes about the fund. So it will look at the fund's carbon footprint and the top ten holdings contribution to the UN Sustainable Development Goals. And then I think what's also really important is it's got the full portfolio holdings of that active ETF and it's updated every quarter so investors can see exactly which companies make up the ETF. [00:13:50][37.4]

Maddy: [00:13:51] I love that transparency and it's good as well just to go through, have a look and get some inspiration for your own investing. We are going to take a quick break for our sponsors, but we'll be right back to hear about why active strategies tend to benefit investors in an economic downturn. So Karen, I do want to test you a little bit because there is a famous story about how Warren Buffett bet a hedge fund manager that a passive strategy, just investing in the broad market index would outperform a hedge fund, trying to actually invest or stock pick once you sort of taking into account phase and things like that for the hedge fund. And he was right. Like historically passive investing has outperformed active when we think that a phase. But I have been reading a lot recently and you did touch on a little bit earlier about how active strategies can tend to benefit investors when the economy is sort of weakening, which is kind of what we're saying at the moment. So why is that the case? [00:14:54][62.5]

Karen Trau: [00:14:55] Yes, I'll answer this in two parts. So if we go back to my earlier question of what is an active ETF, I said they're able to change securities in and out of the portfolio to adapt to the changing conditions. And so active strategies are afforded the flexibility compared to an index or a passive checking ETF, which has limited discretion and it has to follow the benchmark. So that means when markets are down, active strategies that one able to manage the risk in the portfolio. And then two, they also able to identify quality companies which are trading at more attractive valuations so we can take advantage of buying opportunities as well as provide that downside protection. And so there is that higher potential to deliver returns above the benchmark. If we delve a bit deeper into Perpetual's investment philosophy, I mentioned it was around value in companies based on their fundamentals. So looking at their earnings and their balance sheets. And so you might have heard of the metrics like price earnings ratio or what multiple the companies trading at price of book dividend yield debt to equity. And so really looking at how much are investors willing to pay per dollar of a company's earnings. And I think I recall you mentioning this in your podcast a couple of weeks ago. Was it How to survive the market crash? Yes and yes. And so typically in down markets, investors become a bit more rational and they pay more attention to fundamentals and the specific risks of a company. And so that normally translates to markets rerating the business back to fair valuations. And then that would often translate to more superior returns above the benchmark. [00:16:38][102.9]

Maddy: [00:16:39] Yeah, I think that's what we were discussing the other week. That's what we've really seen. It's like over that COVID period we just saw everyone put so much money into, you know, for example, technology companies that were doing so well and now everyone's taking a step back and be like, Ooh, let's go back to normal. Let's all have a look and say, Is this actually what it's meant to be priced at? I am interested, though, you know, during this time, if we want to invest actively, we also are able to invest passively at the same time. Can you combine the two strategies? [00:17:08][29.4]

Karen Trau: [00:17:09] Oh, absolutely. Like I think there is a role for both. And I would say active and passive strategies, they each perform well in different conditions. So we just talked about active strategies. They tend to outperform when economies are weak or there's a dislocation. Conversely, passive strategies, they might perform well if markets are more uniform as an example. So there definitely can be a combination of both. You know, if you have a good view of the market and you know it well, then I would say, you know, have a look at the strategies that might be more suitable for you. But at the same time, if you blend it with active strategies, they allow for the opportunity to add returns above the benchmark and then might also allow you to access certain stocks or sectors that might not be available in a benchmark. And so I would just say, you know, market conditions change all the time. And so there's definitely a role for both at different points in time. [00:18:01][52.3]

Maddy: [00:18:02] So, Karen, when we get experts on the show, we do like to sort of try and get a bit of intel from them and understand, you know, what types of different exposures can ETFs, either active or passive offer. And I guess in particular, like are you seeing any certain ETFs that are more popular at the moment than others? [00:18:20][18.4]

Karen Trau: [00:18:21] Perhaps I find this an exciting question in some ways because the ETF market's really grown in Australia over the last three, five years. And so if you look back at 2017, which really wasn't that long ago, the ETF market was $30 billion across 16 fund managers. And so fast forward five years and the ETF market is now 126 billion across 40 fund managers and 250 products. So yeah, wow. Investors have had more choice than they have ever had before and that's across a whole range of exposures and strategies. So active or passive, different asset classes, Australian shares, global shares, fixed income property. We're now seeing crypto currency and commodities and then within Australian equities or. Equities, you could have specific exposures to a certain country or region or a particular sector to manic. And so I think that's really interesting in terms of providing choice to investors. And we seen more and more fund managers launch ETFs over the last couple of years while Perpetual being one of them. In terms of popularity, I'd probably say global equities and ESG said global equities makes up just over half of the ETF market, and that's been pretty consistent over the last couple of years. With global equities being the largest asset class, I'd probably say that's down to them being a really good diversification tool. And you know, you can definitely invest directly in international stocks through your broker, but it might be more expensive or sometimes you broke up, might only have limited access to markets, so it might only cover us or the developed markets. Whereas ETFs can provide an easier way for you to access more markets around the world and kind of be that one stop shop for diversification. We actually recently launched an ETF Global Equities ETF, which is the Bar Henley Global Share Fund. It's the Ticker Kohli's Globe. They managed by Barry Henley, majority owned subsidiary of Perpetual, and they've got a long history of value investing around the world and they definitely follow that value investing process that I mentioned before. So they look for mispricing in the market, they look for the stocks that are undervalued, and they look to provide or produce a well-diversified, highly active portfolio. And that can cover companies from, you know, North America, Japan, Europe, United Kingdom and emerging markets. I also mentioned ESG ETFs have grown in popularity, and I think that aligns with the trend that we're seeing in everyday life and in matter. You mentioned this like people are being more conscious about the environmental and social impact and they want to invest in a way that aligns with their preferences. And we've seen exponential growth in ESG ETFs over the last couple of years. I think, you know, five years ago, I don't even know if it was $1,000,000,000 market and now it's a $6 billion market. And I think there's almost 30 ESG ETFs on the market. So yeah, definitely a lot more choice and definitely more in line with how people want to invest. [00:21:40][199.2]

Maddy: [00:21:41] Yeah, I think as well, even at a time like this when the market is in a bit of a downturn, as might maybe the same for like you kind of reassess your values and you're like, what am I investing in? So I know that personally for me, I've looked to a lot of SJ ETFs because I'm like, No, this is what I care about. Like, this is what I kind of want to stick to. And it's just a bit easier, as you said, when you can diversify with such a broad range of companies in kind of one investment decision. [00:22:04][23.2]

Karen Trau: [00:22:04] Yeah, definitely. [00:22:05][0.3]

Maddy: [00:22:06] We are big advocates of the idea that you can learn like you can make your investing decisions and you can learn about investing just by, you know, taking in the world around you. And we love getting people's recommendations for books, podcasts, articles, any resources that you have been reading, listening to, watching recently. Karen, do you have anything that you would recommend for us? [00:22:29][23.0]

Karen Trau: [00:22:29] Lately I've been more of a podcast person. I don't know about you guys, but I find them just a good like get on the train or running on the treadmill with gyms. I'll just listen to a podcast for investing. I like the Fast Five Buy Fear and Greed, and that's just very quick five minute episodes that give you the headlines of what's happening in the market. And then for a more lifestyle, one I like Mamma mia outloud. They're the largest women's media network, and I love to hear different perspectives and people's experiences and they talk about absolutely anything and everything. So pop culture, politics, social etiquette, news, you name it. Yeah, definitely. [00:23:12][42.3]

Maddy: [00:23:12] Those two there as investing inspiration to be found everywhere. I'm adamant about this with all of my. [00:23:17][5.2]

Karen Trau: [00:23:17] Yes, I agree totally. [00:23:19][1.3]

Maddy: [00:23:19] I love it. And Karen, final question for you. As we round out reflecting on your experience and your career success, you've been in Perpetual for a few years. You were at the ASX prior to that. What is your number one tip for investing in yourself to get you to where you are today? [00:23:36][16.3]

Karen Trau: [00:23:36] I'd probably just say getting out there and meeting people in the industry. I mean that's certainly where I learnt most of what I know today. I can't say there's that much that comes from book. I just find it easier to speak to someone and I learnt so much over, you know, a lunch or a conference, etc. and I would say the same thing about investing. You know, just start the conversation with your family, your friends, go to the conferences through the year, listen to the podcast to hear about people's insights. I think that will help you make the most informed decision and succeed in your investing journey. [00:24:11][34.3]

Maddy: [00:24:12] So it's like when you write a book, it's like you want to ask another question. You're like, I don't get that for that. You can't ask anyone. Whereas when you're having the conversation, you can be like, What did you mean? What's your experience? Tell me. I love it. Good advice. [00:24:23][11.0]

Karen Trau: [00:24:23] And it's just more fun. Yeah. 

Maddy: [00:24:26] Have you ever Jian? Well, Karen, thank you so much for joining us today. It has been an absolute pleasure. Having you on the show and hearing all about how we could perhaps add some active ETFs to our broader portfolio. So thank you very much for joining us. 

Karen Trau: [00:24:43] Thanks for having me.

Maddy: [00:24:44] So Karen had some great recommendations at the end there. Anything to add to the list this week? Mine is a nothing one. You're not going to learn from it. I've fell in love. And, you know, we were just saying that you learn everything in investing opportunity out of this money. I'm going to quiz you. Okay? I'm going to recommend Stranger Things on Netflix. Yes, I'm very late to the party, but oh, my God, is it good? I'm obsessed. And have you watched Stranger Things? No, I've watched like one or two episodes. I just can't get into it. Don't come at me. Oh, no, I'm not coming at you. But I. But I don't know where you're going to find that investing opportunity if you don't know anything about it, you know? Well, maybe in its popularity, I'm pretty sure Netflix has been doing particularly well off the back of Stranger Things, which is, are they releasing it in like episodes instead of bulk seasons, which is leading to more subscribers? So there you go. Yeah, I don't know. I mean, the first season still. So I'm in that good phase where I'll just watch whenever I want. Actually, second season, six season, what are you recommending? I'm going to recommend an episode of Full Story. It is a podcast by The Guardian and it is called What Do the Uber Files tell us about the company's expansion tactics? Oh, Uber has been in the news a little bit recently for some dodgy dealings that it did in its early days, and this was super interesting. I found it really fascinating. So I would highly recommend going giving that want to listen well we'll link it in the show notes. I don't know if we can link Netflix series machine or it's a Netflix subscriber just like Stranger Things or if you're in a chat about it, let's talk about it because I love it. Jump into idioms, strange things or anything else on Instagram. Why I join a podcast or join our Facebook group, why I joined a investing podcast discussion group. And if you've been enjoying these episodes, please pass them along to a friend. We love growing this community, so I would love you to, you know, WhatsApp it, text it on whatever, whatever floats your boat and otherwise we will catch you next fake buy. 

Karen Trau: [00:26:51] You're in good. 

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