From the October 2009 issue of Research Magazine • Subscribe!

October 1, 2009

2009 ETF Advisor Hall of Fame: Pioneers in Portfolio Management

This year's winners are: the Chudom Hayes Team of Morgan Stanley Smith Barney; Geoffrey S. King of the King Financial Group - Wells Fargo Advisors; and Michael Jones and Doug Sandler of the Riverfront Investment Group.

We proudly present Research magazine's third-annual ETF Hall of Fame. Welcome!

There's no question that exchange-traded funds are revolutionizing the investment world. Their proliferation is unstoppable, their power indisputable; often they're unbeatable.

The practitioners we honor this year -- financial advisors with two wirehouses and one money management firm -- are so committed to ETFs that these funds have become essential to their investment strategies.

Though there is a whopping $9.69 trillion invested in mutual funds vs. $540 billion in ETFs, the latter funds are an increasingly popular product providing the best solution in a broad range of investing scenarios.

The first ETF was introduced on United States stock exchanges in 1993. Now there are 744 funds. Of these, 15 are actively managed and attempt to beat the market in contrast to the bulk of ETFs, which passively follow traditional indexes. Actively managed funds are a controversial concept; and while several new ones are set to debut, widespread use remains to be seen.

Clients understand ETFs best for their transparency, tax efficiency and low costs. But with increasing education by FAs, consumers are starting to appreciate ETFs' value in asset allocation and investing strategy.

Since more and more practitioners are using ETFs in creative ways, it was no easy task for our contest judge, Ronald L. DeLegge, contributor of Research's monthly ETF Reporter department and publisher-editor of www.etfguide.com, to choose this year's winners.

Here's how and why these innovative pioneers are counting on ETFs to build successful, impressive investment portfolios:

The Chudom Hayes Team of Morgan Stanley Smith Barney

Kyle Chudom, senior vice president, wealth advisor, senior portfolio manager

Eric Hayes, vice president, financial advisor, portfolio manager

Advisors since: 1984 (Chudom), 1997 (Hayes)

Home base: Oakbrook, Illinois

ETF AUM: $368 million (of total $500 million)

Community activity: Chudom -- hires paid high school and college interns; Hayes -- introduces children to flying as a profession through the Experimental Aviation Association.

Clients need to be educated about exchange-traded funds -- and Kyle Chudom has found a great way to simplify the process. He uses this analogy: Just as viewing high-definition flat-screen plasma color TV is a far better experience than watching the clunky old black-and-white sets of yore, ETFs are a state-of-the-art tool that lets advisors do a better job of investing than traditional mutual funds and actively managed money.

The approach works well and has helped the eight-member Chudom Hayes Team, with 1,200 accounts invested in the firm's proprietary ETF models, become MSSB's largest discretionary managers of ETF portfolios. In fact, ETFs are a cornerstone of their practice.

The group's transition to ETFs began four years ago. Until then, most portfolios were built using at least four active managers.

But "we kept seeing that one manager would beat the benchmark; another would typically underperform the benchmark by a large percentage; and the other two would be pretty close to the benchmark," says team founder Chudom, 48, named to Barron's "2009 Top 1,000 Advisors: State-by-State."

"Ultimately we decided to spend more time focusing on asset allocation rather than trying to pick the best manager," he continues. "We place greater priority on asset allocation and seeking to minimize expenses than attempting to outperform indexes through active management of individual stocks or bonds."

How profitable have ETFs been? "ETFs have helped grow our practice a bit quicker because they help to distinguish and separate us from others," says Hayes, 36, who joined Chudom in 2000.

The two waited till ETFs had a proven track record, then began converting their practice to ETF portfolios using MSSB's discretionary fee-based Custom Portfolio program.

Focusing on broad, diversified portfolios, the advisors use both tactical and strategic asset allocation. They may, for example, pick a certain sector to emphasize for a specific time period. ETFs are purchased from large providers with low expenses, such as Vanguard and iShares.

Chudom and Hayes are both native Midwesterners -- Chudom, born in Munster, Indiana, Hayes from Lenox, Illinois. By middle school, Chudom had decided to be a financial advisor, having been smitten with the market at age 12. He graduated with a BA from Alma College in 1983 and later completed advanced studies at the Wharton School. In 1984, he joined Dean Witter, a predecessor of MSSB, as an advisor trainee.

Hayes' interest in investing came early as well. At 14, he was reading telecom industry annual reports his dad brought home from work. He graduated from Southern Illinois University in 1995 and went to work as a financial advisor for a large insurance company. Before linking up with Chudom at Dean Witter, he was an Edward Jones FA.

The partners see the "trading mentality" that's developing around ETFs as a possible big pitfall. Says Chudom: "We're concerned that individuals are buying a particular index-based ETF and then selling it in a matter of days, or a couple of months, rather than using it for long-term investing. Some ETFs are being constructed just for [trading]. We hope this fast-money mentality doesn't tarnish the ETF industry."

Another matter of concern is buying two ETFs that may seem different, but in fact there is close similarity in the underlying holdings in the indexes they track. Notes Hayes: "That's one of the things we look at and research very carefully."

Indeed, ETFs' transparency is one of the funds' most appealing advantages: "With ETFs," says Chudom, "we know exactly what we [have]. With a mutual fund or an active manager, we never knew exactly what was held in the portfolio at the time of purchase."

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Geoffrey S. King

Senior vice president-investment officer, King Financial Group of Wells Fargo Advisors

Advisors since: 1994 Home base: Seal Beach, California

ETF and ETN AUM: About $60 million, of that $45 million in ETFs (of total $111.840 million)

Community activity: President, Partners of Parks, Long Beach, California.

Geoffrey King had been a financial advisor for just three years and setting up portfolios using individual stocks, bonds and mutual funds, when he began to seriously question the long-term success of the actively managed investment strategy. Confirming his doubts, he began reading studies showing that year-to-year most active managers underperform their respective benchmark indexes.

So in 1997, King began exploring something new: ETFs. But there were too few funds available to implement a diversified, well allocated portfolio. He would wait two years, when ETFs had expanded dramatically, to begin using the tools as the core holding in his client portfolios.

But hold on: Following a few years of ETF success, King decided to put active management back into the mix.

"The idea was not a case of 'active vs. passive.' It was 'active with passive,'" King, 38, says. Today, the core of his portfolios is invested in passive ETFs diversified among asset classes, with "satellite" actively managed mutual funds employed to complement the indexes.

In theory, "the core/satellite construction allows for the potential to add extra return to the portfolio without increasing risk," says King, who has 125 active clients. About 70 percent are early retirees, the balance up-and-coming business owners.

King, who heads a group of five, including three FAs, says that "ETFs have allowed us to provide better portfolio management to our clients and a better opportunity for them to succeed with their investments." He uses Wells Fargo's discretionary asset management platform called Private Investment Management (PIM).

The Manchester, Conn., native began conducting ETF due diligence in 1997 by back-testing model portfolios using index returns only. To his surprise, the returns weren't much better than those of the actively managed portfolios. However, costs on the index portfolios were much lower, and tax efficiency was higher. King was sold.

"No one has objected to our using ETFs. But though we spend a significant amount of time educating them, a lot of people get confused when they see their statements," King says.

To simplify things, he's come up with a condensed explanation of his complex combined approach. A client's risk tolerance, risk budget and allocation determine what percentages of the portfolio will be allocated to ETFs and to active management.

"Those who want only passive investing will have a risk budget of zero percent, which will allocate the entire portfolio to ETFs," King notes.

The CFP likes iShares and PowerShares, and his top criterion in picking ETFs is the fund's liquidity. "When we make changes, or even if we just rebalance, there needs to be enough liquidity so you don't affect the price change," he says.

The core portfolio is made up of general market capitalization ETFs -- large-cap, small-cap, mid-cap, international, real estate and so on. When making tactical or strategic changes to pinpoint a sector, King uses either an ETF or an active manager.

But, he says, "if we want to drill down even further to a sub-sector, an ETF is a fantastic solution without having to expose ourselves to one or two stock positions; rather, the ETF exposes us to a pool of stocks in that sub-sector."

Graduating in 1993 with a finance-investments degree from Merrimack College, King joined The Boston Company as a Shearson Lehman mutual fund custodian. Relocating to California a year later, he decided he wanted to work with the end investor. He joined Prudential Preferred Financial, in Long Beach, as a fee-only planner, then moved to Prudential Securities.

King has remained with the firm throughout its subsequent acquisitions by Wachovia and Wells Fargo, and five years ago moved his office to nearby Seal Beach.

His biggest business risk was that major relocation, at age 23, to a region where he knew no one except his wife Catherine.

"You're the worst hire I'll ever make," the Prudential manager told him, King recalls. "You're too young, and you don't know anyone to sell our products to!"

But King pledged to persevere. "It worked out," says the now-15-year advisor.

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Riverfront Investment Group

Michael Jones, founding partner, chair; chief investment officer; in industry since 1985

Doug Sandler, founding partner, chief equity officer; in industry since 1992

Home base: Richmond, Virginia

ETF AUM: About $640 million (of total $1 billion)

Community activity: Jones -- board of directors, Redeemer Lutheran Church, helping to rebuild New Orleans houses


Leaving a major wirehouse to start their own money management firm last year, during the worst financial crisis since the Great Depression, was pretty scary for Michael Jones and Doug Sandler. But Riverfront Investment Group has succeeded -- and ETFs have played a pivotal role in expanding managed assets from zero to $1 billion in the first year.

"Our portfolio strategy couldn't exist without ETFs," says Jones, formerly chief investment officer at Wachovia Securities, 2002-08. Sandler, in the equity strategy department 15 years, had risen to become Wachovia's chief equity officer. They managed assets of $8 billion, $2 billion of which was in portfolios composed entirely of ETFs, $6 billion in portfolios that were 50 percent ETFs.

When Wachovia merged with A.G. Edwards and moved headquarters to St. Louis, Missouri, the two opted to stay in Richmond, Virginia, and open their own shop. The firm now consists of 18, including eight money managers.

In 2003 Jones and Sandler began using ETFs extensively. Riverfront's investing approach uses ETFs in a unique way: It combines them with individual stocks. This permits quick and easy modification to overweight certain asset classes and underweight others.

"That strategy didn't exist prior to the invention of ETFs. Our combination [approach] is the best way to solve investment problems," says Jones, 46. "We use individual stocks for which there is no ETF substitute -- Apple, say -- but when we want a lot of exposure to Brazil, for example, we buy an ETF that gives it to us in a nice, diversified manner."

Focusing on stocks his entire career, Sandler, 39, says: "I'm a stock picker, but the fact that I use ETFs shows how much I believe in them. At times, an ETF is just a better tool."

To select equity ETFs, he puts to work a four-part analysis. He starts by zeroing in on what he's trying to accomplish; for instance, buying the aerospace and defense industry because it tends to be insensitive to big economic shifts. Sandler also concentrates on market cap and relative strength, or performance. Lastly he looks at liquidity and fees.

The team uses PowerShares, iShares, Barclay's, State Street and occasionally smaller providers. "We use whatever ETF fits the strategy," Jones says.

The partners like ETFs as a sensible way to invest in a volatile asset class like biotech. "The sector is very attractive and cheap," Jones says. With an ETF, "you can buy a diversified basket of biotech companies rather than taking a risk and buying a company with a drug that turns out to do poorly in FDA trials."

As Sandler points out: "The typical retail investor can't own enough biotech companies to properly diversify the risk -- but when they own a whole group in an ETF, the home runs will outweigh the strikeouts."

Managing money for financial advisors for the past 15 years, Jones, born and reared in Nashville, Tenn., graduated from The College of William and Mary with a BA in economics and received a Master's from the Wharton School in 1998.

He was mortgage-backed securities portfolio manager at a predecessor bank to Wachovia, then joined Alliance Capital Management as head of mortgage-backed securities investing. He next returned to Wachovia and in 2002 was named chief investment officer.

Buffalo, N.Y.-born Sandler earned a BS in accounting in 1992, then an MBA from the University of Richmond in 2000. He started out trading bonds at Wheat First Butcher Singer, a Wachovia predecessor, and was with the firm a total of 16 years.

With Riverfront's launch, Jones and Sandler met with FAs to tell them their strategy to help clients navigate the financial crisis. "We talked about a new way to run money that offered the hope of better reaction to horrible markets and also better reaction in opportunity markets," he recalls.

Riverfront stays away from actively managed ETFs because, as active portfolio managers, they seek to execute specific strategies with ETFs.

"The last thing we want to happen," Jones says, "is to buy an ETF expecting a certain set of characteristics and then the active manger changes his mind."

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