The Hunger for Yield

This is a summary of a session from the Money Management Institute’s 2013 Spring Convention. The panel was made up of three experts all from large, institutional asset management firms:

  • Daniel Loewy, Co-Chief Investment Officer, AllianceBernstein
  • Donald Plotsky, Head of Product Group, Western Asset Management
  • Robert McConnaughey, Head of Equity, Columbia Management

The session moderator was Kevin Keefe, Executive VP, Advisor Group.

Can you discuss some of your methodologies around asset allocation and portfolio construction?

According to Plotsky, a lot of clients are worried that fixed income is no longer a viable investment. He and his firm reject that notion and believe that investors need to re-think their approach to asset allocation. Income is a critical component of any long-term investment program, he stressed.

Loewy believes that there are three keys to successful asset allocation:

  1. pro-active – long-term assumptions about strategic asset allocation doesn’t cut it anymore, must have a pro-active approach to keep clients in the game to capture long-term risk premium
  2. flexibility – traditionally, risk was managed from the bottom-up using individual portfolio sub-components, investors want to manage absolute risk, not relative risk, requires a more flexible approach to be able to take advantage of opportunities
  3. customization – there is no one-size fits all portfolio, need to focus on individual outcomes such as growth, income, real return or capital preservation

Continue reading

Asset Allocation: Is Modern Portfolio Theory Dead? (2/2)

This is the second part of the summary of a session from the Money Management Institute’s 2012 Fall Solution Conference. You can read part 1 here.

  • Michael Jones, Chairman and Chief Investment Officer, Riverfront Investment Group
  • Colin Moore, Chief Investment Officer, Columbia Management, $339 billion AUM
  • Howard Present, President and Chief Executive Officer, F-Squared Investments
  • Steve Murray, Director of Asset Allocation Strategies, Russell Investment Group

How do fees affect your product decisions taking into consideration QE3 and a persistent low rate environment? Does paying 30-50 bps for bond allocations affect your product choices?

Murray said that fees do affect their product decisions, but that they always try to identify strong managers and the fees are a tradeoff versus the additional return that they’re expected to provide. Since Russell has a manager of managers structure allows them to move between managers with different fee levels as well as incorporate other products such as ETFs and mutual funds.

Fees have a higher impact when the product they’re attached to performs like Beta, Present ob served. Over the last decade, it was very difficult to extract value from equities as an asset class, while bonds appear that they will be difficult going forward. In 2008, the average target date fund was down 28%, so it didn’t matter if a manager was slightly above or slightly below that average. Relative performance in a down market is rarely appreciated by clients. You should be more aggressive with fees on beta products versus those that are designed to generate alpha, he said.

Does your philosophy of using low cost, transparent, liquid beta in the form of ETFs make it harder for your products to coexist on a sponsor platform alongside more traditional ones? — Randy Bullard

Jones proposed that their philosophy, which combines stocks, bonds and ETFs into dynamic allocation solutions is complementary to the more traditional solutions (like Russell). there is more than one way to create value besides picking stocks from a narrow slice of an asset allocation pie chart. They added another value dimension by adjusting the amounts allocated in each slice of the market based on the prices and momentum in each asset class. It’s not an either or decision to use their products or traditional. There’s a philosophical diversification that can be complimentary instead of competitive. Continue reading

Asset Allocation: Is Modern Portfolio Theory Dead? (1/2)

This is a summary of a session of the Money Management Institute’s 2012 Fall Solution Conference.

Michael Jones, Chairman and Chief Investment Officer, Riverfront Investment Group
Colin Moore, Chief Investment Officer, Columbia Management, $339 billion AUM
Howard Present, President and Chief Executive Officer, F-Squared Investments
Steve Murray, Director of Asset Allocation Strategies, Russell Investment Group

This was an interesting discussion since each of the panelists approach asset allocation from a different perspective.  Jones believes that modern portfolio theory (MPT) is dead and that asset allocation should be more fluid and dynamic so they shift the pie chart around.  Riverfront has a simple methodology, which states that the price you pay is the number one determinate of the upside potential and downside risk of an investment.  They feed the price into a proprietary optimization process to create a portfolio that tries to make money in a worst case scenario while still maximizing the upside potential.

Moore agrees that the standard process is deeply flawed and feels you shouldn’t maximize return for a given level of risk.  Instead you should figure out what is the maximum level of return that the client can accept.

F-Squared believes that downside risk management has a disproportionate impact on clients, according to Present, so they factor it into their portfolios at a higher level.  Standard deviation is used to represent investment risk and maximum drawdown to represent the client’s perception of portfolio risk, he said.

Murray disagrees with Jones and believes there is some value in modern portfolio theory but that it is just one data point.  It’s not enough to rely on by itself.  At Russell, they know that different asset classes follow different pattens in the market so they use using different asset classes to offset each other in a portfolio by combining long and short term market processes, he stressed. Continue reading

JPMorgan Doubles Model SMA, UMA Business in 2010

FundFire has an interesting article about the tremendous growth of JP Morgan’s managed account programs last year.  The article, written by Tom Stabile, describes some of the key features that made JPM’s programs so successful.  It also points out some new trends that are appearing in the industry.

Open Architecture

Is their UMA open architecture or not?  Here’s what the article says:

JPMorgan is the exclusive provider of SMAs to the fast-growing Chase UMA program, which combines SMAs, mutual funds and exchange-traded funds in a single custodial account. The UMA has an open architecture platform for mutual funds and ETFs, with product selection from a Chase due diligence team.

Well, since no outside SMA managers are available, it’s not really open architecture.  But how important is this?  It had no measurable effect on their ability to gather assets last year.  Does this mean that open architecture isn’t important to clients?

Keeping SMA management in-house  is certainly more profitable.  Managers usually charge 30 bps for providing their models to a UMA.  JPM can pocket this to boost profits or use it to lower their overall fees and undercut their competitors.

Models Matter

I’ve been hearing a lot about how models-only is the wave of the future and assets in manager-traded SMAs are disappearing fast.  According to the article, JPM’s models-only programs added $1.6 bil in 2010 while their traditional SMA programs lost $0.4 bil.

The data underscores that models are an increasingly vital component for SMA manager business lines, says Jed Laskowitz, head of distribution for JPMorgan Funds Management, the retail arm that also runs the SMA business.

This same trend seems to be occurring around the industry.  Three managers alone – Allianz Global Investors, Neuberger Berman and Lord, Abbett & Co. – transitioned more than $20 billion in assets to the model portfolio format in 2010, according to a report by Cerulli Associates.

Last week I spoke to Mike Everett, head of Business Development at MyVest.  He said that he sees the market share of traditional SMA programs declining due to the increasing popularity of models-only.  This trend will negatively impact technology vendors that rely on manager connectivity as their primary selling point.  “In a models-only world, connectivity to managers doesn’t matter,” Mike noted.

The Most Interesting Part

This is the part where I’m quoted:

The Chase brokerage arm does appear to have an edge helping it outpace many competitors, says Craig Iskowitz, managing director of Ezra Group, a consultancy. One of those is being able to tap its asset management affiliate.

Another strength appears to be how Chase’s UMA already has a format many competitors are trying to establish – fully discretionary client relationships, which means advisors don’t have to check back with clients on every investment move, and a model that keeps most portfolio decision-making at the home office.

“It’s way more efficient to have it done in the home office,” Iskowitz says. “And if you have a good [investment] mix, it can be powerful because studies have shown that asset allocation is 80% of your return.” He says adding in a solid technology platform with robust rebalancing capabilities can greatly increase efficiencies for a brokerage operation.

I decided to fact-check myself and found that 80% is incorrect.  The most commonly cited research (this one and this one) report that asset allocation makes up more than 90% of a portfolio’s return.  Although, a recent article by Thomas M. Idzorek (published in Morningstar Advisor magazine) claims that “After removing the market movement, asset allocation and active management are equally important in explaining return variations.”

More Bad News for Bonds

Another instance of someone predicting that bonds will fall out of favor in 2011:

[Jed] Laskowitz says the SMA business overall may be set for a rebound this year, with signs that investors may tilt to equities.

I wrote about how some managers are predicting poor performance for bonds in a prior blog posting entitled, Why Bond Portfolios are a Flawed Retirement Strategy.  Laskowitz believes that investors will re-evaluate their portfolio risk and look to increase their weight in equities, which naturally leads to more interest in SMAs.

MFA – The 600 lb Gorilla

While UMA is still the pretty girl in the room, Mutual Fund Advisory (MFA) continues to suck up assets at every sponsor and JPM is no exception:

Most of their focus is on the mutual fund business, where JPMorgan enjoyed significant inflows of $20.7 billion last year, placing second industry-wide, behind only PIMCO’s $64.1 billion, in new assets into actively managed long-term mutual funds and ETFs, per data from Strategic Insight.

What I’d like to see is a detailed comparison of the JPM UMA/SMA programs versus some of their competitors to try and identify where they have advantages that could be the drivers of their AUM growth.

After-Tax Asset Allocation

The calculation of after-tax asset allocation is key to determining asset location, which can significantly impact an investor’s after-tax returns according to a paper by William Reichenstein, Ph.D., CFA (a copy is here as well).   While this paper doesn’t mention the term “tax alpha” explicitly, it discusses some interesting tax management issues.  I have experience with developing technology and product strategy around managed accounts, so the author’s advocacy of after-tax allocation peaked my interest.

What the paper states is that funds going into a tax-deferred account, like a 401(k), should be adjusted by multiplying the amount by (1 – tn), where tn is the expected tax return in retirement.  So if you expect to be in the 25% tax bracket when you retire (assuming there is such a low bracket by the time you actually get to retire) you would multiply the pre-tax funds by 75% (1 – 25%) to account for future taxes.

So, if you had $2,000 to invest between a tax-deferred and taxable account, putting $1,000 into each account would not be an equal allocation using this method.  You would need to put somewhere around $1,140 into the tax deferred, which would be the same as $858 after-tax.  I know this doesn’t quite add up to $2,000, but I think this calculation would require a bi-nomial solution and I don’t have time to figure that out.  You get the idea anyway, I’m sure.