Ready-made 'model portfolios' are growing -- but there is no
standardized tracking of performance, making comparisons
difficult
By Asjylyn Loder
This article is being republished as part of our daily
reproduction of WSJ.com articles that also appeared in the U.S.
print edition of The Wall Street Journal (April 8, 2019).
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 08, 2019 02:47 ET (06:47 GMT)
Copyright (c) 2019 Dow Jones & Company, Inc.
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