Image Credit: Christophe Vorlet
By Jason Zweig | 12:39 pm ET May 15, 2015
When hiring people who call themselves strategists, be aware that some act more like tacticians instead.
That is one lesson from several recent setbacks among ETF strategists, asset managers who specialize in picking exchange-traded funds—those popular investment baskets that mimic market benchmarks like the S&P 500-stock index or the Barclays U.S. Aggregate bond index.
Until recently, ETF strategists have been sizzling hot. By March 2014, they had garnered $103 billion in assets, up from $44 billion at the end of 2011. But assets slid to $91 billion at year-end 2014 and likely dropped further in the first quarter as disappointed investors pulled money out, says Ling-Wei Hew, an analyst at Morningstar, the investment-research firm.
Some strategists, such as Vanguard Advisers, a unit of the giant Vanguard Group, and Ibbotson Associates, a subsidiary of Morningstar, bundle ETFs into highly diversified portfolios that they patiently hold.
Yet other strategists rapidly trade from one ETF to another, from ETFs to cash or from cash to ETFs. That is more tactical than strategic. When they think a market is about to go down, these tacti-strategists will move to cash; if they are bullish, they will get out of cash and back into ETFs. While such trading could limit your losses during bad markets, it often comes at a high price in the form of annual management fees and other costs that can exceed 2%.
Such strategists may manage bundles of ETFs in separate accounts, advise mutual funds or even just sell their recommendations of when to trade which funds to financial advisers.
“Financial advisers have a real appetite for this kind of product right now, since it enables them to spend less time managing portfolios and more time managing the relationship with their clients,” says Jennifer Muzerall, a senior ETF analyst at Cerulli Associates, a financial-research firm based in Boston.
But can anyone reliably beat the market with funds that are designed only to match the market?
This past week, Hartford, Conn.-based Virtus Investment Partners, which manages $55 billion in mutual funds and other assets, removed ETF strategist F-Squared Investments as an adviser to five Virtus funds.
The largest of them, now known as the Virtus Equity Trend Fund, underperformed the S&P 500 by at least two percentage points annually the past four years in a row; last year, it lagged behind the market by 11.9 points.
The Virtus funds had annual portfolio turnover rates of between 129% and 337%, implying that they owned their typical holding for as little as 3½ months, and annual expenses of up to 2.23% for their most popular share class, or $223 per $10,000 invested.
Marketing materials prepared by F-Squared in 2010 said its model portfolios “create a means of modestly outperforming the S&P 500 in normal growth markets, while meaningfully outperforming the S&P 500 in bear markets.” The firm claimed to have walloped the market by an average of 13 percentage points annually over the five years ended Dec. 31, 2010.
In an interview in October 2012, Howard Present, then F-Squared’s chief executive, told me, “People now are thinking about thriving in bull markets and surviving in bear markets, and that’s what we’re all about.” He also told me, “This strategy has been run on a live basis back to 2001 using client assets.” Marketing materials then available on the F-Squared website showed one of its strategies going completely to cash in mid-2002, thus sidestepping most of that year’s 22.1% decline in the S&P 500.
But according to the Securities and Exchange Commission, F-Squared had exaggerated its past performance and didn’t begin managing money for outside clients until 2008. F-Squared consented to the SEC’s findings last December and paid $35 million to settle the claims.
F-Squared declined to comment for this column on the SEC settlement or how the firm formerly represented its results. An assistant to Mr. Present’s lead attorney, Brendan Sullivan, a partner at Williams & Connolly in Washington, says the law firm doesn’t comment on pending cases. In his response in March to the SEC’s complaint, Mr. Present denied all wrongdoing.
In the first quarter of 2015, investors—or, more likely, their financial advisers—pulled $2.9 billion from the five Virtus ETF strategy funds.
In a statement about its termination as an adviser to the funds, F-Squared said, “While Virtus’s decision is disappointing, it is not unexpected and does allow us to pursue new opportunities in the mutual fund space.”
Another leading ETF strategist, Chicago-based Good Harbor Financial, has also stumbled. The Good Harbor Tactical Core U.S. Fund, a mutual fund that follows mathematical formulas to trade ETFs, lost 20.9% last year, trailing the S&P 500 by 34 percentage points. The fund charges between 1.23% and 2.23% in annual expenses. Morningstar estimates that investors withdrew approximately $2.3 billion from Good Harbor in the fourth quarter of 2014 alone.
Good Harbor had no comment.
If your financial adviser is recommending portfolios or mutual funds assembled by ETF strategists, insist that total annual expenses be well under 1% annually and portfolio turnover less than 100%. And if your adviser implies that it is easy to beat the market with funds that can only match it, he either has a lot to learn or thinks you do.
Source: The Wall Street Journal