P&I: How did MERS decide to make this shift to ETFs?
Mr. Burns: We had managed between 30% and 40% of assets in-house through index funds, enhanced indexes, futures and active strategies. In 2018, we began building toward VBA (valuation-based allocation) that would look at global market segments and tilt the portfolio based on long-term value projections. To do this, we realized we might have to make some big shifts on a quarterly basis. ETFs emerged as the most liquid instruments to do that — especially given the reduction in index futures counterparties after the global financial crisis. Most of the work for the transition was setting up trading relationships. And, I have to say, the model and vehicle really proved itself amid the COVID drawdown in the spring of 2020. We were able to trade $2.5 billion within a week— to rebalance out of fixed income, into high yield and equities very quickly.
P&I: How have ETFs enhanced portfolio operations to the benefit of your members?
Mr. Burns: At the end of the day, when you're making pension payments, you simply need to raise cash, right? So on a practical level, we've had no problem at all with ETF liquidity, but we've also found there to have been substantial cost savings. Now obviously some of that is the move away from active managers, but ETF costs have also come down. For instance, we pay 3 basis points for core S&P 500 stock index exposure. And when you add in securities lending income for certain ETFs, you can actually come out ahead on the cost. In fact, my job and the job of my team is much easier because of the proliferation and growth in ETFs.
P&I: So why aren't more funds investing this way?
Mr. Burns: Candidly, one of the issues is size. Think about fixed-income ETFs. Is there enough capacity for a $200 billion fund to put all of their fixed-income investments into ETFs? I don't think the market is quite big enough yet. On the equity side, it's probably getting there. Of course, registered investment advisers have been deep into ETFs for decades. But five to 10 years from now, I think you will find most of my peers with greater assets under management making this transition.
P&I: MERS has nearly $1 billion currently invested in the new S&P Quality, Value & Momentum ETF offerings from Invesco. How did that come about?
Mr. Burns: It was really a collaborative process to craft an investment solution that would meet not only our needs, but also the larger investment community. We've had a long relationship with S&P on the benchmarking side and have utilized their indexes for years. We trust their research and implementation. S&P brought in Invesco to bring scale, liquidity and product expertise.
P&I: As you look across the rest of your portfolio, do you start seeing ETFs for more asset classes?
Mr. Burns: Yes, we've expanded our view and seeded a portfolio of natural resources equity ETFs as a complement to an active manager who is invested in liquid commodities. But ultimately, we look at the types of exposures we want and what vehicles makes the most sense — whether that is a private manager, a public manager, or holding stocks and bonds, or buying futures and ETFs. Right now, there is a tailwind for ETFs, which allows us to add the exposures that we want. But when you start looking at loans and private credit — investments where liquidity is less of a factor — my bias is toward a traditional active manager with expertise in underwriting and credit analysis.
P&I: How do you screen for ETFs to use?
Mr. Burns: First off, we're looking at what exposures will match our model. Then, we look at cost and liquidity of an individual ETF to see if it lines up, particularly if we have to buy or sell under stress. We're constantly watching for changes in the marketplace and even taking calls with new entrants — particularly around ESG ETFs given the support that those products are seeing. We don't have policies that demand an ESG lens on the portfolio, but some of these products are starting to build decent track records. Of course, companies with good governance, who are good corporate citizens, tend to do better than companies that are bad corporate citizens. You particularly see this in emerging markets. So, we view ESG more through an active lens. And we might invest in an ESG ETF because we think it's going to outperform one of the traditional indexes that we've used to rebalance the portfolio. Also, I could see MERS using active ETFs in the future. It would depend on whether they match the strategy and our exposure needs.
P&I: Thank you very much for your time. Is there anything you'd like to add?
Mr. Burns: It's been amazing to watch the democratization of finance and how ETFs have been part of that change. When I started 20 years ago, you needed significant computing power and consultants to access parts of the market that you can now get to right through your smartphone — and the costs have come down dramatically. Today, you can build a globally diversified portfolio that meets the needs of individuals and organizations in a much more efficient manner than was even possible 10 years ago.
