My “Repackaging” Pet Peeve: Do Other Advisors See This As Well?

/My “Repackaging” Pet Peeve: Do Other Advisors See This As Well?

My “Repackaging” Pet Peeve: Do Other Advisors See This As Well?

By | 2017-08-18T16:59:59+00:00 July 27th, 2017|Guest Posts|4 Comments
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(Last Updated On: August 18, 2017)

Like many advisors, I often find myself reviewing accounts and historical performance for clients and prospects with investments at other firms. Of course I see all the usual suspects like annuities, mutual funds with loads, 12B-1 fees, etc. Financial professionals who work on a commission basis regularly tuck these products into their clients’ portfolios – whether or not they are the best option (they just have to be suitable). These issues are nothing new and there are already many efforts devoted to educating clients around these potential conflicts of interest (e.g., FINRA).

This note focuses on a different issue I regularly come across that gets under my skin. In particular, many financial professionals build portfolios with various mutual funds, ETFs, and third-party managers.

However, these portfolios, in aggregate, often strongly resemble the total market portfolio.

For example, many of the large wire houses use a variety of different active managers and funds. While each may employ a different strategy, their strategies often diversify themselves away. One manager over-weights what another under-weights and so forth. This observation is really just a statistical version of William Sharpe’s mathematical argument regarding active management in aggregate (a notion Jack Bogle has often repeated in marketing Vanguard’s index products).

The end result can be a portfolio that is very similar to the total market. Unfortunately, all of the expertise and effort to build this portfolio wind up costing significantly more than just purchasing a total market index fund. Indeed, both the advisor who constructed the portfolio and the funds themselves typically levy fees that can add up to as much as 1-2% per year.

Source: Aaron Brask

This begs the question of why bother?

I can think of at least two reasons. The first is that advisors want to have the appearance of adding value. When a client looks at their statement and sees all of the different holdings, they likely assume they were strategically chosen based on the extensive experience of the advisor and/or advisor’s firm. The second reason is that many of the larger firms operate pay-to-play schemes whereby they also get fees from the fund companies. In my view, this is really just a lesser known version of the 12B-1 fee.

Active funds and managers are not the only way to play this game. Indeed, I have seen independent firms play the same game with index funds while touting their ultra-low fees (I difficult pitch to resist for many investors). I cannot count the number of times I have seen portfolios diversified between growth and value, large and small, etc. In my mind, this is not much different than charging a fee to break the market into smaller pieces and glue them back together.

 

I acknowledge some advisors may argue the granularity provides them with the opportunity for strategic rebalancing. In my experience, however, this is often not the case. The portfolios are built for the appearance of diversification but end up paying unnecessary fees.


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About the Author:

Aaron is an accomplished Mathematical Finance PhD who runs his own registered investment advisor (RIA) - Aaron Brask Capital LLC. Before starting his own firm, Aaron's last role was at Barclays Capital where he built and ran two global research teams focused on quantitative equity and derivatives strategies for the firm's top clients. He has been published and quoted in major newspapers and magazines including the Wall Street Journal, Financial Times, Barron's, and Risk magazine. Aaron Brask Capital is an independent, fee-only registered investment advisor. That means I do not promote any particular products and cannot receive commissions from third parties. In addition to holding me to a fiduciary standard, this structure further removes monetary conflicts of interests and aligns my interests with those of my clients. In terms of spirit, my firm embodies my own ethics, discipline, and expertise. In particular, my analytical background and experience working with some of the most affluent families around the globe have been critical in helping me formulate investment strategies that deliver performance and comfort to my clients. I continually strive to demonstrate my loyalty and value to my clients so they know their financial affairs are being handled with the care and expertise they deserve.
  • Eric Weigel

    Agree Aaron. I have seen portfolios with equal amounts of Russell 1000 Growth & Value as well as the same for Russell 2000 Growth and Value. At the end of the day the value and growth indices give you the core portfolio (which many cases is a bit cheaper to own). There is also this sense of diversifying manager risk but many people fail to see just correlated these portfolios usually are.

  • Thanks. Manager risk is a fair point. In my experience I just do not see enough managers generating real alpha. Even if some do, their returns get offset or diluted by others. I simply find it astounding to see financial professionals diversifying this risk and ending up with the market portfolio – with higher fees, turnover, etc.

  • Hannibal Smith

    You think it bad now, just wait until they ahold of all the factors! The only valid argument I can see for something like a R2K Growth and R2K Value split is in the weighting. You’d get a bit more overweighting of value with a split than with the full R2K. But I bet the alpha its very marginal.

  • Agree with the weighting / tilting, but even that could still be more sensibly represented as market + value portfolio. The only defense I can think of would be for tax harvesting (more granular holdings allow for more opportunity there), but I rarely see any traces of TH.