About the Editor
Samuel Lee is an ETF strategist for Morningstar and editor of Morningstar ETFInvestor, a monthly investment newsletter. Prior to becoming editor, Lee was a fund analyst on Morningstar's passive funds research team, where he covered alternative, dividend, and actively managed ETFs and performed quantitative modeling of ETF strategies.

Lee joined Morningstar in 2008 as a data analyst, where he evaluated ways to measure and improve the firm's data quality.

Lee holds a bachelor's degree in economics, with honors, from Grinnell College.

Investment Strategy
Morningstar ETFInvestor scans the globe for value and improving fundamentals across virtually all asset classes. Editor Samuel Lee draws upon academic and practitioner research — including Morningstar's sizeable bench of stock, bond and fund analysts — to find reliable drivers of outperformance.

Morningstar ETFInvestor features two real-money portfolios.

The ETF Income Portfolio assembles a high-quality collection of income-generating ETFs with the goal of earning 5% in excess of the 30-day T-bill rate over a full business cycle. The portfolio adheres to a benchmark-agnostic strategy in its search for absolute returns.

The ETF Global Asset Allocation Portfolio, on the other hand, is more benchmark sensitive. It seeks undervalued asset classes with improving fundamentals. The strategy seeks to beat the 60/40 MSCI ACWI/Barclays US Aggregate benchmark over a full business cycle, with the least risk possible.

Sep 01, 2014
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Samuel Lee,
Editor, Morningstar ETFInvestor
Samuel Lee is an ETF strategist for Morningstar and editor of Morningstar ETFInvestor, a monthly investment newsletter. Prior to becoming editor, Lee was a fund analyst on Morningstar's
Featured Posts
Some Good ETF Innovation
I’ve written nice things about PIMCO’s IndexPLUS funds before (“Leverage Edge,” June 2013), so I was pleased when PIMCO announced on Aug. 15 that it’s planning to launch two IndexPLUS exchanged-traded funds, PIMCO International Fundamental IndexPLUS AR Strategy Active IFI and PIMCO Fundamental IndexPLUS AR Active USFI. “AR,” by the way, stands for “Absolute Return.” The two new funds are to be managed by Saumil Parikh and Bill Gross, respectively. (You can find the prospectus filing here.)

The IndexPLUS strategy involves borrowing money to invest in an equity index “plus” a bond portfolio. Leverage is achieved through total return swaps, derivatives that provide economic exposure to an asset for a funding cost (usually quoted in LIBOR, the short-term rate at which banks lend to each other, plus a spread). Swaps usually don’t require a lot of margin per unit of exposure, so the fund is free to invest its collateral in an actively managed bond portfolio, usually some variation of the firm’s Total Return strategy. Each dollar in an IndexPLUS fund behaves like $1 in the index and $1 in a bond portfolio, or 200% gross exposure.

The Fundamental IndexPLUS strategy tracks the Enhanced Research Affiliates Fundamental Index, or eRAFI. You’re probably familiar with the vanilla RAFI, which weights stocks by four fundamental measures of economic size: current book value and five-year average sales, cash flow, and dividends. The RAFI provides a value tilt. The eRAFI augments each measure with a quality signal. Sales is adjusted by cost margin to reward more-profitable firms. Cash flow is supplemented with debt coverage ratio, and firms with ratios below their industry mean are penalized. Dividends are augmented with net share buybacks. Book value is adjusted by “net operating assets,” penalizing companies with book value in excess of retained free cash flow (having GAAP earnings outpace free cash flow is a sign of financial chicanery). The adjusted measures tilt the eRAFI toward quality stocks relative to the RAFI.

IFI will track the Enhanced RAFI International Large Index and charge 0.89% of assets per annum, only 0.06% higher than the expense ratio for the institutional share class of the mutual fund PTSIX. However, the swaps will cost about 0.40% to 0.50% plus 1-month LIBOR. Swap costs are not included in the expense ratio. The economically significant part of the swap cost is the spread to LIBOR, so you can think of IFI as costing 0.89% plus 0.50%, or 1.39% per year. However, because you’re getting $2 of economic exposure for each dollar, the cost for each dollar of gross exposure is around 0.70%.

USFI will track the Enhanced RAFI US Large Index and charge 0.86%, 0.07% more than the institutional share class of the Silver-rated mutual fund PXTIX. The swap cost’s spread above LIBOR will be around 0.20%-0.30%, resulting in a 1.16% annual economic cost and a 0.58% cost for each dollar of gross exposure.

The funds will invest their collateral in an absolute return strategy that targets 2% to 3% above cash. USFI’s bond portfolio will be run by Gross, so it’s likely to behave like some variation of PIMCO Total Return PTTRX. PXTIX, also run by Gross, provides some clues. I regressed the daily returns of the fund against its index’s and PIMCO Total Return’s daily returns over the past year. The fund has behaved like 100% exposure to the index and 60% exposure to Total Return, with an extremely tight fit (adjusted R-square of 0.986).

IFI’s bond portfolio will be run by Saumil Parikh. It’s not clear which fund is most representative of Parikh’s model portfolio. As far as I can tell, the only PIMCO mutual fund of which he is sole manager is PIMCO Unconstrained Tax Managed PUTIX, which he took over in early 2014 after Marc Seidner abruptly left the firm for GMO.


The IndexPLUS funds, it should be noted, are hideously tax-inefficient. The swaps convert equity capital gains into income. The swap income generates high headline yields. For example, PXTIX has a trailing 12-month “yield” of 11.7%. An investor who consumes this “income” is really just consuming capital gains in another form. I’d invest in PIMCO’s IndexPLUS funds only through a tax-deferred account; to do otherwise is close to financial malpractice, in my opinion.

As a plus, the funds’ embedded leverage allows you to shelter more dollars in tax-deferred accounts. The ideal user of these funds is a young, aggressive investor with tax-deferred space. These aren’t for ma and pa.


PIMCO has long wielded financial innovation like a scalpel, carving out neglected bits of the markets and packaging them in neat strategies. Its flagship Total Return strategy was one of the first to overlay derivatives on a plain-vanilla bond portfolio, eking out extra returns for a smidgen of more risk years before it became de rigueur. An earlier version of the IndexPLUS strategy, PIMCO StocksPLUS PSTKX, came out in 1993. PIMCO Enhanced Short Maturity MINT, which came out in late 2009, was one of the first—if not the first—ETFs designed to exploit the void created by tightening money market regulations, a move that has since been aped by other ETF sponsors. Its launch of the Total Return ETF BOND was the first blockbuster actively managed ETF. More recently, PIMCO has brought hedge-fund trend-following to the masses with the launch of PIMCO TRENDS Managed Futures Strategy PQTIX, one of the cheapest such funds. The imminent launch of PIMCO’s IndexPLUS funds as ETFs is more innovation in this vein.

Best regards,

Samuel Lee
Editor, Morningstar ETFInvestor

Interesting Reads

Economist Robert Shiller on the mystery of high stock prices.

Economist Brad DeLong’s excellent rebuttal.

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