More advisors are using Schwab's ETF manager but some of them dislike the company's tactical approach

November 18, 2011 — 5:28 AM UTC by Lisa Shidler

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Brooke’s Note: There is considerable intrigue around Windhaven because it is perceived as both a tool for RIAs and, by some, as a potential competitor. When Schwab bought the asset manager of ETFs, there was ooing and awing about the price paid. See: A look inside Schwab’s big deal with a small asset manager It didn’t perform well in 2010 but supposedly that was because it was built to manage risk, not maximize gains. But this has been a pretty bad year so we were curious to see how Windhaven was doing. It’s a complex story.

Windhaven Investment Management Inc.'s three portfolios underperformed their benchmarks for 12-month period ended Oct. 31, but the company is raking in assets despite the relatively low returns.

Since Charles Schwab & Co. acquired it a year ago, the Boston-based money manager’s assets have surged 77% — to $8 billion from $4.5 billion. The company has also added 30 new Schwab advisors as clients. See: Schwab’s purchase of Windhaven made its asset growth soar — and RIA assets may be the afterburners.

“The three strategies are performing as expected, over the long term — which is what they are designed to do,” says Bryan Olson, president of Windhaven. “We broadly diversify across 40 different asset classes. These funds are there to protect on the downside, and there will be a lower kick on the upside in a stronger equity market.”

A look at the numbers

These portfolios, comprising primarily exchange-traded funds, are built to help investors weather bad markets by lessening their risk while often not generating quite as much return in an up market. The company uses its own set of proprietary models, ranking asset classes and adjusting portfolio weightings several times a year for the highest returns given the risk. See: Windhaven’s success draws attention to emerging ETF managers.

The founder of Windhaven who developed this approach is Stephen Cucchiaro. See: As Windhaven assets head moonward, Stephen Cucchiaro keeps right on warning of falling skies in New York.

Windhaven’s Diversified Growth Portfolio was up 3.3% for the 12 months through October, compared with a 7.2% gain for the growth benchmark (a blend of 60% U.S. equities and 40% Barclays U.S. Diversified Bond Index). For the same time period, Windhaven’s Diversified Aggressive Portfolio was up 2.5% compared to a gain of 8.1% for the S&P 500. Windhaven’s Diversified Conservative Portfolio was up 2.1%, compared with 5% gain for its benchmark, the Barclays Capital Aggregate Bond Index.

However, Olson says the funds are performing better so far this year, noting that last December was a very strong month for the market. Year-to-date through October, two of the three portfolios outperformed their peers.

Year to date through October, the Diversified Conservative Portfoliio was up 2.4%, compared with a gain of 4.4% for its benchmark. But Windhaven’s Diversified Growth Portfolio outperformed its benchmark over the same period,1.8% to 0.6%, and the Diversified Aggressive Portfolio lost 0.2% while it benchmark fell 1.5%.

Schwab’s muscle pushes Windhaven forward

Morningstar analyst Michael Wong predicts that Windhaven’s assets will continue to grow despite the less-than-stellar returns.

“If Windhaven were by itself it could have a bumpy period, but with Charles Schwab’s backing, I don’t see the flows going down,” he says.

Wong says Schwab has been successful in luring its self-directed customers toward Windhaven because of the managed-account approach.

“Hopefully, investors will look at a multiyear track record,” he says. “Even though it has underperformed, I believe it’ll still continue to grow assets at a strong pace.”

Staying for the long-term

In fact, Windhaven executives are hoping that investors do stick with the funds for the long term, Olson says. He points out that these funds are attractive to investors who are worried about risk and seeking strong long-term results.

For instance, Windhaven’s Diversified Growth was up a cumulative 105.4% from its Jan. 1, 2002, inception through Oct. 31, compared with an increase of 52.5% for the benchmark. Likewise, Windhaven’s Aggressive fund was up 131.9% since Jan. 1, 2002 compared to the S&P 500 Total Return Index, which was up 32.3% for the same period.

Windhaven’s Diversified Conservative Portfolio was up a cumulative 77.9% since its inception on Jan. 1, 2002, compared with a gain of 73.6% over that period for the Barclays Capital Aggregate Bond Index.

While the long-term growth is strong, Olson concedes that these funds typically do better in a down market but won’t perform as well in an up-tick. For instance, when the markets tanked in 2008, Windhaven’s Diversified Growth Portfolio was down only 15.4% compared to a loss of 22.1% for the growth benchmark. Its Diversified Aggressive Portfolio lost 20.7% in 2008, versus a decline of 37% for the S&P 500.

But in the more favorable conditions of 2010, Diversified Aggressive was up only 9.1% compared with a 15% gain for the S&P 500 and Diversified Growth was up just 8% compared to a gain of 12.1% for the growth benchmark.

Not all ETFs are the same

Olson says the funds have two dimensions — one of which is strategic and rarely changes, while the other is tactical and changes frequently.

He says the strategic aspect is broadly diversified. “Part of the reason we have the strategic piece, is because there’s no way to predict things,” he says.

The short-term underperformance of Windhaven highlights the fact that all ETF strategies are run differently, says Michael McClary, chief investment officer of ValMark Advisers Inc., an Akron, Ohio, registered investment advisor with more than $1 billion in ETF assets.

“All ETF managers aren’t created equal. Just because they’re using ETFs doesn’t mean they’re all being run the same way. People buy ETFs because they think active managed funds don’t work,” he said.

But McClary points out that some ETF managers are in fact managing the funds using tactical approaches.

Investing philosophy

Although 30 more Schwab advisors have become Windhaven clients, some Schwab advisors simply don’t like Windhaven’s approach. Advisors have also worried that Windhaven is a competitor.

Roger Hewins, president of Hewins Financial Advisors LLC, which has headquarters in San Mateo, Calif. and Minneapolis, and manages about $2.5 billion in assets, says he doesn’t use Windhaven because his firm has a different philosophy than Windhaven.

“Philosophically, that kind of active strategy seeking to hedge downside and beat the market isn’t something we believe in, and we don’t practice it. Ours is more strategic. We’re not believers that people can consistently time the markets through a variety of active trades.”

He also acknowledges that there’s certainly a push for active strategies by advisors because clients are fearful. “Clients are fearful and some advisors wants a magic bullet and I think the pursuit of the magic bullet is futile. We don’t believe in it.”

Top notch marketing

Jim King, an advisor with Balasa Dinverno Foltz LLC of Itasca, Ill., applauds Schwab’s marketing efforts, saying the funds’ growth is being propelled by Schwab branches.

“Most advisors feel that their secret sizzle is asset allocation, and because of that they probably won’t use Windhaven,” he says.

He says it’s no surprise that the portfolio aren’t always going to have outstanding results.

“Even Warren Buffet has off years. When you are selling on performance — no matter how great a strategy is — sometimes it underperforms. Right now, you could say they’re underperforming. But they’re being smart about how they communicate it.”

RIA Sharon M. Snow, chief executive of Metropolitan Capital Strategies LLC in Manassas, Va., manages just under $100 million in ETF assets, and also agrees returns can be a challenge. Her funds are now going to be on Envestnet’s platform.

She points out that bumpy results are par for the course. “They’re doing asset allocation and to time that many asset allocations correctly is nearly impossible.” Every manager who does that will return to the average returns at some point.”

One chief investment officer of a big RIA who asked not to be identified pointed out that hedge-fund mimicking funds like Windhaven should be doing well in rough market.

But he says market conditions are so confusing that hedge funds themselves are doing badly — and worse than Windhaven in aggregate.

The Dow Jones Credit Suisse hedge fund index was down by 6.1% and the global macro hedge fund index was down 9% year to date. For more results click here


Mentioned in this article:

Morningstar, Inc.
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Top Executive: Joe Mansueto



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