BAC Bank of America Corporation

By Asjylyn Loder 

These days it is easy to comparison-shop for everything from sneakers to paper towels. But if you're in the market for a ready-made portfolio of exchange-traded funds -- an increasingly popular product with the potential to make or break your finances -- it may be a lot tougher.

Sold by big banks, discount brokerages, robo advisers and even fund issuers themselves, prepackaged investment portfolios have become a popular way to buy ETFs. Yet because the firms involved in this burgeoning business face few rules when it comes to reporting performance data to potential clients, side-by-side comparisons of portfolios can be difficult, if not impossible, for consumers.

"It's a giant black box," says Ken Schapiro, founder and president of Backend Benchmarking, a startup that compares and ranks robo advisers, which use online tools to recommend and manage portfolios often made up of ETFs. "These are some of the most important decisions that people have to make and they can't possibly comparison-shop."

Hidden money

The $3.8 trillion U.S. ETF industry includes 2,000 products that invest in everything from Argentine debt to pet-care companies to the Cboe Volatility Index, better known as Wall Street's fear gauge. The variety makes ETFs appealing as portfolio building blocks, but turning that bewildering array of funds into a sensible savings plan is something many investors prefer to outsource.

Enter ready-made portfolios. These are mixes of ETFs matched to investors' goals, timelines and risk tolerance. Some are highly standardized, while others are tailored to specific investors.

This "model portfolio" industry is so opaque that no one really knows how big it is, or even agrees on what to call it. Also known as ETF strategies, ETF managed accounts or ETF portfolios, the business broadly refers to money managers who use ETFs to build investment portfolios instead of, or in addition to, mutual funds or individual stocks and bonds. The involvement of robo firms such as Betterment, Wealthfront and Ellevest only adds to the confusion. because while their offerings aren't included under the broad umbrella of ETF models, they do much the same thing.

Fund researcher Morningstar Inc. counts more than 1,200 ETF managed portfolios, with assets of almost $122 billion. However, many of the biggest model-portfolio providers don't report to Morningstar, including Bank of America Corp., which has about $75 billion in its ETF models and is gaining more than $20 billion in new assets a year. Morningstar also doesn't include assets managed by the fast-growing digital-advice platforms.

"We're capturing just the tip of the iceberg," says Ben Johnson, Morningstar's director of fund research. "The majority of the money managed in these models isn't being reported."

To get a handle on the size and growth of models, financial-technology firm Broadridge Financial Solutions Inc. recently developed an algorithm that identifies clusters and patterns in fund ownership, says Andrew Guillette, a senior director at the firm. His latest research identified almost $355 billion in ETF model assets, up from $190 billion two years ago.

Industry insiders agree that the market is growing fast, bolstered by the proliferation of low-cost ETFs, the evolution of digital investing and a shift toward fee-based advice. Model strategies can be replicated for thousands of clients, freeing up advisers to focus on other parts of their business. For investors, it takes the guesswork out of choosing how much to invest in international versus domestic firms, stocks versus bonds, ultrasafe Treasurys versus riskier junk-rated debt.

"A fully allocated, diversified portfolio is very often in the best interests of the client," says Patty Loepker, head of research directed advisory at Wells Fargo, which has about $22 billion in ETF model portfolios, not including its digital advice platform. "That means advisers can focus on the clients broader needs, rather than choosing individual investments for each client."

Like mutual funds, ETFs are pooled investment vehicles that buy stocks, bonds or other securities. Unlike mutual funds, ETFs can be bought and sold all day on stock exchanges, just like shares of Apple Inc. or General Motors Co. Fund performance is visible in real time, fund strategy is detailed in public filings, holdings are regularly disclosed and fees are clearly posted.

Combine those ETFs into a portfolio, however, and different rules apply. Models fall under decades-old rules on adviser advertising. The Securities and Exchange Commission, Wall Street's top regulator, allows firms to showcase performance, as long as it isn't false or misleading, but disclosure isn't compulsory. Late last year, the SEC sanctioned two robos for making false statements about investment products and publishing misleading advertising.

Four years ago, Mr. Schapiro started what he calls a "garage project" to track the performance of robo strategies. He opened accounts at several firms and, after amassing almost a year's worth of performance data, mocked up the first issue of what became Backend Benchmarking's Robo Report. One of his first subscribers, he says, was the SEC.

Some digital advice firms weren't happy, Mr. Schapiro says. Vanguard Personal Advisor Services and Wealthfront closed his accounts. He has since had friends open accounts in their own names to make it harder for firms to shut him out.

Vanguard declined to comment directly on Backend Benchmarking, but says its personal advisory service builds customized portfolios tailored to each investor's needs, so it isn't a robo or a model. Its other advisory models report results to Morningstar.

Wealthfront says it discloses the performance of its portfolios on its website. The firm says it shut down Backend's accounts because it believed that the methodology was inconsistent, and that in one instance the firm misrepresented Wealthfront's results, Kate Wauck says. Wealthfront also thought the Backend report was self-serving, she says, since Mr. Schapiro's other venture, Condor Capital, is an advisory firm.

Condor, which manages $1 billion, does offer ETF portfolios to its clients, though it isn't a robo, Mr. Schapiro says. Mr. Schapiro doesn't publicly disclose Condor's results. He spun Backend Benchmarking out as it own firm more than two years ago.

A future fix?

Advisers aren't always eager to advertise performance because even a well-constructed portfolio won't always beat the competition, says John Grady, a partner at DLA Piper in Philadelphia. "They want to compete on service and thoughtfulness and cost."

Calculating real performance can be tricky because firms might have dozens of portfolios with varying degrees of customization, Mr. Grady says. Some rely almost exclusively on ETFs, while others include mutual funds or individual securities. Some strategies try to minimize taxes, and others offer a "glide path" that shifts the portfolio into less risky securities over time.

The result is a hodgepodge that makes side-by-side comparison of model portfolios difficult. Some firms don't report results at all and for those that do, there's no one accounting standard.

"There would be a real value in having a standardized process and measurement," says Tim Clift, chief investment strategist at Envestnet, an investing platform for advisers. "I hope we get there, but this is an emerging industry for sure."

Until then, investors should take time to research what they are buying, says Morningstar's Mr. Johnson. Advisers have tools that aren't typically available to mom-and-pop investors, such as Envestnet, Morningstar or in-house research platforms. While those systems don't include every model and robo on the market, clients should ask their adviser to explain how a particular strategy has performed compared with peers, whether that performance is hypothetical or reflects the experience of actual accounts, and whether those results reflect all relevant fees.

Cost is one thing investors can compare, and that information is relatively easy to find, especially when it comes to robos. Backend Benchmarking's reports are free. When looking at costs, it is important to consider the management fee of the model itself, the fees charged by the underlying funds and any additional wrap fees or trading commissions.

Some in the industry argue that comparison-shopping based on performance may not be a great idea anyway -- especially if it leads to performance chasing.

"That's completely the wrong way of thinking about it," says Dan Egan, managing director of behavioral finance at Betterment, a $16.7 billion robo adviser. His advice: Ignore short-term variations in past results and instead stick with an inexpensive, diversified portfolio.

Ms. Loder covers ETFs and market structure for The Wall Street Journal. Email her at asjylyn.loder@wsj.com.

(END) Dow Jones Newswires

April 07, 2019 22:28 ET (02:28 GMT)

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