Kevin Ellman, chief executive of Wealth Preservation Solutions in Ridgewood, N.J., began using exchange-traded funds in its portfolios some 10 years ago, after he had become disenchanted with active money managers. “I find that it’s very difficult to pick mutual funds that consistently meet or beat their appropriate benchmarks. And I found myself spending a lot of time trying to justify–why did we select this mutual fund if you can just invest in an index and get better or comparable performance at a lower expense? It’s a pretty compelling argument, so I decided to begin using index strategies for the core portfolio.”
Now, Ellman uses ETFs almost exclusively for clients’ equity portfolios and many parts of its fixed-income portfolios. He has gotten no pushback from clients, Ellman says, because many of them have also become disillusioned with active money managers for the same reasons. The firm, which specializes in asset management, estate planning and business succession planning, caters primarily to business owners in the Tri-State Area.
Core and satellite
WPS’s core portfolio always has the same elements, including small-, mid- and large-cap stocks, both value and growth, as well as developed international and emerging market international stocks. Some components of the core portfolio may be overweighted in order to achieve extra performance, says Ellman. “We’re trying to add value by over- and underweighting certain sectors and certain countries rather than trying to pick stocks.” At present, he says, “we are overweighting mid- and small-cap stocks because a lot of research shows that coming out of a recession, mid- and small-caps will outperform large-cap stocks, and we’ve slightly overweighted emerging markets because, again, research shows emerging markets often outperform coming out of a recession. And that has held true.”
In addition, the firm deploys a satellite “defensive” portfolio around the core, also using ETFs, says Ellman. “In there right now, we are basically betting on inflation, for all the fairly obvious and well-documented reasons: There’s a tremendous amount of money being printed, we’re going to have a lot of deficit spending, we think that ultimately long-term interest rates will creep back up, we think there’s a lot of danger the dollar may decline in value. As an inflation hedge, we’ve shorted the dollar, we’ve shorted long-term Treasuries and we’re long gold.” The portfolio was also short the S&P 500 for a time and made some money, he says. “We’re trying to add value here by making some strategic investment decisions as opposed to picking specific stocks or making specific security investments.”
Ellman says WPS still uses one mutual fund in individual municipal bond portfolios, the Templeton Global Bond fund. “That’s one sector in which I haven’t found a suitable ETF alternative yet. So if the account is large enough to justify using a manager, that’s our first choice for bonds, and if the account is not large enough, then we use ETFs.”
The firm also does quite a bit of work with alternative investments. “That’s part of our value add,” says Ellman. WPS uses equipment leasing, real estate trusts and Man Investments’ futures fund. It also has some exposure to hedge funds and private equity, though Ellman says he would not recommend these to clients at present, even though much research says this is precisely the time to invest, because they’re a hard sell and a lot of people don’t want to hear about them.
WPS works with the major ETF providers: iShares, PowerShares, S&P, SPDRs, First Trust, Vanguard, Rydex and Wisdom Tree. Ellman and his colleagues are constantly comparing expenses of new offerings and their actual holdings to see whether one strategy has some advantage over another. Recently, the firm started to look at the holdings of the financial sector, particular dividend funds, he says. “We made a conscious effort to select funds that had lower exposure to financials. I tend to be very pro-dividend, so I am attracted to the various high dividend strategies, while trying to keep the exposure to financials under control.”
Besides their advantages for clients–lower expenses, more tax efficiency and transparency–ETFs are a boon to management practice because they can be traded during the day, says Ellman. “Let’s say, we want to make a change in all our clients, say we want to sell one ETF and either move to cash or purchase another ETF. It’s very difficult to wait until the end of the day to see how the trade settles, so you can make the trade the next day; you can have some movement in the market if you’re managing mutual funds–that can really hurt, they can go against you or could be in your favor. With ETFs, you can make your sell and your purchase simultaneously, you know what you got; you can make the change and move on.”
Michael S. Fischer ([email protected]) is a New York-based financial writer and editor and a frequent contributor to Wealth Manager.