After a “whole career” working at Standard and Poor’s, Richard Wolfe, co-founder and principal at Saddle River Capital Management, became a CFP in 1992 and started a financial planning firm modeling retail clients’ portfolios on endowment funds.
Back then he was using mutual funds, but was excited about exchange-traded funds. “I wanted something flexible; you didn’t have to buy a lot of securities, it wasn’t loaded with mutual funds — because I wanted something that was more transparent than mutual funds — so ETFs were just perfect for that,” he said.
The New Jersey-based Saddle River offers its portfolios to 401(k) plan sponsors through Invest n Retire, a technology company that provides recordkeeping and trading systems for defined contribution plans. Plan sponsors can choose from five core portfolios with different levels of risk.
Wolfe started Saddle River with his son, Doug, who had spent 14 years at Salomon Smith Barney trading equity securities, in 2004.
“The way we managed risk was we put more fixed income in,” Wolfe said. “So our aggressive growth [portfolio] had no fixed income in it down to the most conservative portfolio had 60% fixed income in it. It had an allocation to U.S. equities, developed markets and emerging markets. It had commodities in it, it had real estate, and it had fixed income.”
Early on, when there weren’t enough ETFs covering the fixed income market to choose from, Saddle River used closed-end funds to fill the gap, “but as ETFs developed, [now] they’re in everything — more things than we even thought about — so that made it very easy for us to not only put together an endowment-style portfolio, but to manage it the way we wanted to,” Wolfe said.
Wolfe described the research process he uses at Saddle River: “We would download on the equities all the securities on each of the indexes — large-cap, mid-cap, small-cap, that sort of thing — and we ran some fundamental analysis on those and some technical analysis and we scored each one of them.”
The portfolios are rebalanced every quarter, Wolfe said, and the team can “alternate and shift our allocations and manage our allocations depending on what is going on in the marketplace. For instance, last year emerging market commodities were getting killed, so we shifted our allocation, which was normally, say, 10% for each one to 1%.”
One reason the firm has adopted ETFs so enthusiastically is that they provide exposure to areas investors might have trouble finding in a mutual fund. “There are ETFs that cover areas that mutual funds are hard pressed to cover,” Wolfe said. “When you get into things like real estate and commodities, even emerging markets, there aren’t a whole heck of a lot of mutual funds that cover that.”
ETFs also provide more flexibility. “Most 401(k)s, when they’re set up with mutual funds, they pick a handful of mutual funds” and may make some changes after a year or two. “With ETF portfolios, we can change ETFs every quarter if we want to.”
For example, Wolfe said, “Last year in May, that’s when the fixed income market really got hit because that’s when the Fed said they were going to start raising interest rates and bonds got clobbered. At the end of June when we decided to rebalance, we moved the fixed income to bank loans and emerging market fixed income and things that were not affected by the Fed policy. We were able to make those changes —Bang! — Just like that, and settle down our fixed income allocation.”
ETFs also have better expense ratios, Wolfe said. “Every time I talk to a client, they’re saying to me, ‘Can you help me with my 401(k)?’ We can go in there with an ETF portfolio that’s a lot less expensive than a mutual fund portfolio for the plan sponsor — with recordkeeping, payroll — and provide education and advisory services for less than 100 basis points. Try to do that with mutual funds.”
ETFs haven’t been picked up in 401(k)s much, but that’s about to change. “The big problem with ETFs in a 401(k) so far is that ETFs are traded like stocks,” Wolfe said. “A lot of people — the Fidelities and Schwabs and people like that — have difficulty putting ETFs in 401(k)s, but now open-architecture platforms are out there.”
He continued, “The bottom line is ETFs have not being making much headway in the 401(k) marketplace; they’re going to start.” In fact, Schwab launched an all-ETF 401(k) in February. Prior to that, TD Ameritrade launched a turnkey program that opens up non-proprietary ETFs and mutual funds to advisors trying to get into the retirement business.
The last obstacle to adding ETFs to 401(k)s, then, might be the participant.
“It does add a layer of confusion,” Wolfe acknowledged when asked how participants have responded to ETFs in their 401(k)s. “We do have to explain to participants what an ETF is. Let’s face it, mutual funds are so plugged into 401(k)s now and people are so accustomed to them. We were lucky enough to have people in human resources who understood ETFs and liked the idea of lower costs.”