Active Management: Skill versus Luck

This is a summary of a panel discussion from the MMI 2013 Spring Convention held in NYC on April 22-24.

Moderator:
John Thompson, Partner, Head of Investment Solutions, Hewitt EnnisKnupp

Panelists:
Ed Foley, Director, Dimensional Fund Advisors
Brian Hansen, President & COO, Confluence Investment Management
Robert G. Smith, President & CIO, Sage Advisory Services

According to the Standard & Poor’s Indices Versus Active Funds (SPIVA) Scorecard:

The year 2012 marked the return of the double digit gains across all the domestic and global equity benchmark indices. The gains passive indices made did not, however, translate into active management, as most active managers in all categories except large-cap growth and real estate funds underperformed their respective benchmarks in 2012. Performance lagged behind the benchmark indices for 63.25% of large-cap funds, 80.45% of mid-cap funds and 66.5% of small cap funds.

Performance returns over the past five years clearly show that active management has had a tough time, Smith opined.  While many more fixed income managers beat their indices, equity managers tend to do better during rising markets.  Maybe equity managers could take after fixed income and do more sector rotation, he pondered.04-11-13-Failure-of-Active-Management-Equity

According to Hansen, there is a lot of “closet” benchmarking going on.  These managers are going to have a harder time trying to outperform over time.  Confluence believes that it’s better to do research and locate undervalued stocks for long-term payouts than to try and mirror the index.  They do have an ETF strategy group that exclusively uses passive benchmarks, he noted.

DFA maintains a blend between active and passive management, Foley explained.  Research shows that performance from active management is driven by a mixture of skill and luck.  The question is, how do you separate the skilled managers from the ones who were just lucky?  Also, can you structure portfolios around reliable premiums, he asked?

What are some long-term investment aspects that your firm is focusing on?

Sage offers three broad investment strategies; active fixed income, structured products, and tactical asset allocation using ETFs, Smith reported.  He believes that the hot button strategies going forward will most likely be global tactical active allocation, multi-asset income, and fixed income strategies that take advantage of ETFs on an opportunistic basis.  They avoid buy and hold strategies, which failed in 2008 when the financial crisis effectively changed “core plus into core minus”, he joked.

DFA started in 1981 and have always had close ties with the University of Chicago, Foley explained.  Their philosophy on building portfolios is encompassed in three principles; 1) Markets reflect all information available to buyers and sellers, 2) portfolio structure determines performance and provides significant contribution to how performance is generated; and 3) diversification, he said. Continue reading

The Wizards of ETFs – Behind the Curtain (2/2)

This is a review of a session from the Money Management Institute’s 2012 Fall Solution Conference.  This is part two of a two-part series.  You can read part one here.

Moderator:

  • Benjamin T. Fulton, Managing Director of Global ETFs, Invesco Powershares Capital Management, LLC

Panelists:

  • Sam Turner, Director of Large Cap Portfolio Management at Riverfront Investment Group
  • Jill Iacono Mavro, Managing Director, Head of National Accounts, State Street Global Advisors – $337 billion in ETF assets globally, 94% in US, SPY launched in 1993
  • Dodd Kittsley, Senior Product Manager & Head of ETP Research, iShares

How much weight should advisors put on liquidity when evaluating an ETF?

There are two levels of liquidity: primary and secondary markets, Mavro said. On the primary market, an ETF is as liquid as the underlying index that it tracks. It depends on how easy is it for authorized market participants to trade the basket of securities that represent the index. On the secondary market, liquidity is defined by how often the ETF is traded. The more it is traded, the thinner the spread between the bid and ask prices. Advisors should look at both levels together, not just one or the other.

Turner disagreed and stated that primary market liquidity and fees are the two worst reasons to select ETFs.  Riverfront focuses primarily on exposure and have never had an issue getting out of an ETF due to lack of primary market liquidity, he said.

Secondary market liquidity can become an issue when investing ETFs according to Michael Jones, also from Riverfront Investments, who was in the audience.  He provided an example where Riverfront was the seed investor for an international ETF that was currency-hedged (The ETF happened to be DBX MSCI EAFE Hedged Equity Fund, symbol: DBEF). Primary market liquidity wasn’t a problem for them since they were working directly with the authorized participant and had great execution.  However the use of the currency hedge became more and more expensive to the point where they had to pull their investment due to the high marginal trading costs of bringing on each additional client, he said.

Should You Avoid ETFs with Low AUM?
An article in Barrons makes the case that low AUM is not a good liquidity indicator for ETFs:
“…asset levels aren’t always the best proxy for liquidity. Unlike a stock, an ETF can still have strong liquidity even if its trading volume is low or its assets are tiny. That’s because the underlying stocks’ or bonds’ liquidity is usually the best way to measure an ETF’s real ease of trading. Barron’s asked market-making firm Knight Capital to rate the liquidity of 30 small ETFs whose 2012 returns are about double those of the S&P 500 as of early November. If you judge ETF tradability by the way its components trade, as Knight does, you’ll find lots of low-asset ETFs with more-than-expected liquidity. “I wouldn’t shy away from ETFs that have low volume or low assets. You just have to be smart about how you trade it,” says Eric Lichtenstein, managing director of Knight’s ETF trading desk.”

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The Wizards of ETFs – Behind the Curtain (1/2)

This is a summary of a session from the Money Management Institute’s 2012 Fall Solution Conference entitled ETFs: To Develop or Not Develop?  This is part one of a two-part series.  You can jump to part two by clicking here.

Moderator:

  • Benjamin T. Fulton, Managing Director of Global ETFs, Invesco Powershares Capital Management, LLC

Panelists:

  • Sam Turner, Director of Large Cap Portfolio Management at Riverfront Investment Group
  • Jill Iacono Mavro, Managing Director, Head of National Accounts, State Street Global Advisors – $337 billion in ETF assets globally, 94% in US, SPY launched in 1993
  • Dodd Kittsley, Senior Product Manager & Head of ETP Research, iShares

How has the trend of advisors shifting towards Rep as Portfolio Manager (RPM) changed your business model?

Turner believes RPM is more of a challenge than a threat since it is the end client experience that matters. Competition from RPM raises the bar, with each crisis causing a shakeout of weaker products and players. The next crisis may not be a market downturn but could be a repeat of 2009 when many government central banks were trying to stimulate their economies through quantitative easing, he said.

Many of the advisors who Turner has spoken to are over-weighted in cash because their client’s are nervous. If the market continues its current upswing into 2013, then this lack of participation could be a risk for these advisors, he warned. Their clients may fire them because they were too cautious.

RPM has also been a huge growth engine outside the US, Kittsley stated. Financial transparency rules enacted in the UK will be a huge catalyst for growth in that market. ETFs are well-suited for managed books of business.

StateStreet’s distribution efforts started in the RIA segment, Mavro explained. They treat it more like an institutional service model. iShares and PowerShares have been focusing on RPM for many years and it has become a differentiator for them on larger platforms Regulatory reform targeting advisors running discretionary portfolios often result in more outsourcing, which benefits firms like Riverfront, she claimed.

Related WM Today Posts
Has Rep as PM Growth Peaked?
Rep as PM: The Inside Scoop

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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.

Moderator:
  • Michael Jones, Chairman and Chief Investment Officer, Riverfront Investment Group
Panelists:
  • 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

Rep as PM: The Inside Scoop – Part 2

This post is a summary of a session from the MMI 2011 Fall Solutions Conference that was held in NYC. It is part 2 of a 2 part series. Click here to read Part 1.

Moderator:
Marc Zeitoun, Managing Director, Head of Distribution, Rydex/SGI

Panelists:
Jay Link,
Managing Director, Managed Solutions Group, Merrill Lynch
Peter Malafronte,
Executive Director, Managed Accounts, UBS
George Raffa, National Sales Manager, Asset Management Division, SVP, Raymond James

I felt that this was one of the most useful sessions at MMI because the panelists all shared lots of information about their firm’s advisory business, including statistics (my favorite) and details about the inner workings of their programs. Also, the moderator did an excellent job moving things along and asked insightful follow-up questions, which gave the panelists a chance to elaborate on some key concepts and helped make the session more interesting.

How do Rep as PM and Rep as Advisor programs work together?

Peter agreed that the two platforms are complimentary and the decision as to which to choose is mainly a client preference issue. It depends on whether or not they want to be involved in the decision making process, he said.

Also, Rep as Advisor is sometimes considered to be a “farm league” for RPM clients, Peter joked. Once a client has worked with an advisor in a non-discretionary program, has developed trust and understands how the advisor thinks about investments, portfolio construction and managing risk, that client is more likely to feel comfortable moving into a Rep as PM program, he asserted.

Marc added that the conventional wisdom says that RPM assets are the stickiest and least litigious. Additionally, they have higher levels of client satisfaction.

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Diversify, Diversify, Diversify – 3 Ways to Help Advisory Products Succeed in Volatile Markets

“How can clients improve diversification in their portfolios?” was the question Roger Paradiso posed to those attending this session at the MMI Tech and Ops Conference 2011.  Client’s portfolios aren’t performing as expected and their needs aren’t being met, he said, they are looking for solutions. The recent rise in volatility in the market, he explained, combined with the correlation of many previously uncorrelated asset classes, has increased the priority of diversification for many investors.

Moderator:

Roger Paradiso, President and Chief Investment Officer, Private Portfolio Group, Morgan Stanley Smith Barney

Panelists:

Mark Thomas, Senior VP, Head of Managed Accounts, PIMCO
Joe Mrak, CEO, FolioDynamix
Donna Davis, Director of Trade Management, Private Portfolio Group, Morgan Stanley Smith Barney

Alternative investments help to diversify portfolios. How are you introducing alternatives into advisory solutions?

PIMCO uses a forward-looking process when designing client solutions, Mark explained. They evaluate what vehicle, product or platform makes sense and decide on the right structure for each client. Support for 40Act funds, limited partnerships, private funds, and separate accounts are all included in their program.

One issue when introducing new products is ensuring that there is enough capacity, Mark said. PIMCO is continually looking for ways to lower the minimums in their alternative structures and vehicles to make them available to a wider audience.

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Rep as PM: The Inside Scoop – Part 1

This post is a summary of a session from the MMI 2011 Fall Solutions Conference that was held in NYC last month.  It is part 1 of a 2 part series.  You can read part 2 by clicking here.

Moderator:
Marc Zeitoun, Managing Director, Head of Distribution, Rydex/SGI

Panelists:
Jay Link,
 Managing Director, Managed Solutions Group, Merrill Lynch
Peter Malafronte, 
Executive Director, Managed Accounts, UBS
George Raffa, National Sales Manager, Asset Management Division, SVP, Raymond James

I felt that this was one of the most useful sessions at MMI this year because the panelists all shared lots of information about their firm’s advisory business, including statistics (my favorite) and details about the inner workings of their programs.   Also, the moderator did an excellent job moving things along and asked insightful follow-up questions, which gave the panelists a chance to elaborate on some key concepts and helped make the session more interesting. — Craig

Rep as PM (RPM) and Rep as Advisor (RAA) are the fastest growing fee-based programs in the industry, increasing assets 40% annually over the past three years.  Any asset management firm that doesn’t have a strategy to address RPM is missing the boat.

Which term is more accurate, Rep as PM or Rep as Advisor?

Jay believes that the term Rep as Advisor makes more sense since advisors do quite a bit more than just portfolio management.  They act in some ways as both investment consultants and wealth managers.  This is an entrepreneurial community and some RPM advisors consider themselves to be style-specific and market themselves as money managers.  Other advisors see RPM as just another level of service that provides a better overall client experience.  They use discretion as a tool to deliver more holistic advice.

Peter really doesn’t like the RPM title, since advisors are acting in an investment advisory capacity. Rep as PM doesn’t adequately capture what the advisor is doing for the client. Planning, liability side of the balance sheet, trusted council. RAA is more accurate.

George feels that RPM works best for teams that are headed by a financial planner with one person that oversees the portfolios and spends 100% of their time on it.

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