Could FSPs Be Emotional Rescue for Advisors?

During the December 2018 turmoil in the markets, were self-directed advisors or advisor portfolio managers (APMs) affected by emotions more than fund strategist portfolios (FSPs), those funds created with ETFs and mutual funds and traded by firms like BlackRock?

It appears, on the surface, that emotion took some type of toll, as self-directed advisors’ performance was worse than FSPs, according to an Envestnet report comparing the two groups in the December period.

The report compared December performance for each asset risk level, from capital preservation, conservative, moderate, moderate growth and aggressive growth, and in each, advisor models lagged, especially when including standard deviation. For example, in aggressive growth, advisor models were down 7.08% with a 3.80% SD, while FSPs were down 6.96% with a 1.81% SD. The largest differential in performance was in the most conservative, capital preservation, with advisor models down 1.88% (2.43% SD) while FSPs were down 0.86% (1.28% SD).

But perhaps “emotional” isn’t the right word as it connotes a knee-jerk reaction based on market volatility, argues John Harris, managing director and head of global advisor sales at Envestnet. “I don’t think that’s what’s happening here,” he says.

He points out that over a three-year period, advisor models outperformed FSPs but had taken on more volatility and risk: An Envestnet study between the second quarter of 2015 and the first quarter of 2018 showed average performance for advisor models was 4.61% with an SD of 2.57%, while over the same period, FSP average performance was 4.10% with an SD of 1.13%.

He describes three reasons for the differential that might explain December:

• The bull market made advisors and clients more comfortable with equity investing, and advisor models allowed for “more equity exposure that definitely would impact the downside when markets go down 9% in a month,” Harris explains.

• As advisor models are more likely to customize client portfolios, there may be more legacy stock positions — for example, a retired client who owned his former company stock and wanted to hang onto it — or the portfolio may be holding onto stock for tax reasons, Harris says.

“Advisor-directed portfolios have individuals making decisions and they are allowed to open up the parameter a bit beyond what an FSP [could do],” Harris says. “An FSP manager would never accept outside positions into strategies. It’s either take those strategies that they’re creating and believe in them, or don’t. It’s a tighter process.”

• Rebalancing plays a part as well, Harris says. For example, with an FSP there is quarterly or semiannual rebalancing, whereas for an advisor model, it’s at the discretion of the advisor. “They may be letting winners ride, or maybe it’s tax season, but it could be number of things that come into play and why they haven’t rebalanced the model,” Harris says.

That could be a detriment to the portfolio, as Envestnet found that today rebalancing could add 30 basis points of performance to the portfolio.