Study gives advisers bad wrap

In-house portfolio management underperformed benchmarks, Cerulli shows

Sep 9, 2012 @ 12:01 am

By Dan Jamieson

Financial advisers who manage mutual fund and ETF portfolios may be doing their clients a disservice.

That warning comes from Cerulli Associates Inc. in a report that cites research showing that adviser-run mutual fund wrap programs underperformed benchmarks significantly in 2010 and 2011.

Though not surprising to many observers, the finding is important. Adviser-as-portfolio-manager programs, which let advisers pick their own funds and exchange-traded funds, are the single biggest segment in the managed-account sector, holding about $660 billion in assets, according to Cerulli.

The research firm estimated that these adviser-run programs returned just 4.3% over those two years, versus 9.9% for packaged-fund-allocation programs run by broker-dealers, and 15.9% for a blended benchmark of 60% in U.S. stocks, 10% international stocks and 30% in bonds.


Advisers did do better in down periods, such as the second quarter of 2010 and the third quarter of last year, according to Cerulli's research.

The new research shows that advisers are engaging in market timing to some degree, said Scott Smith, associate director at Cerulli.

Specifically, advisers who manage fund wrap programs have been paring back on risk when markets sell off.

But this loss aversion hurts returns when markets rebound, as in the third quarter of 2010 and the fourth quarter of last year, when packaged programs run by broker-dealers outperformed, as did the benchmark.

“Advisers generally lag because they're out of investments in bad markets, then forget to get back in,” Mr. Smith said.

Clients, of course, have a lot to do with missing the market, he said.

“The idea of sticking with a long-term allocation — investors don't want to hear it” in volatile markets, Mr. Smith said.

He said that he would expect to see similar underperformance in fee accounts run by registered investment advisers.

The research marked the first time Cerulli has estimated returns for adviser-run wrap accounts.

Many observers said the Cerulli findings were not surprising.

“These advisers tend to take the lead from their customers [and if customers are] scared of the market, clearly the adviser will push them to a more defensive position,” said Louis Harvey, president of Dalbar Inc.

“No offense, but these brokers are not money managers,” said Matthew Tuttle, founder of Tuttle Wealth Management LLC, which runs $75 million in assets in tactical strategies.

“Real value would be added if they were offering something that was truly tactical,” he said.

Of course, advocates of passive investing believe that any kind of market timing is silly.

“Money managers are susceptible to the same behavioral biases that normal investors are, such as market timing and chasing the herd,” said Sheldon McFarland, vice president of portfolio strategy and research at Loring Ward, a turnkey asset management provider.

Morningstar Inc. has uncovered a similar pattern of portfolio underperformance that resulted from investors and advisers buying and selling at the wrong time. In 2010, the latest year for which data are available, the average domestic fund returned 18.7%, but the average fund in-vestor's return was 16.7%, according to Morningstar. The difference represents lost returns as result of poor market timing.

Over three years, the performance gap was 128 basis points per year. Over five years it was 98 basis points, and for 10 years, 47 basis points.

Taxable bond funds also came in behind the benchmarks over all those periods, the data showed.

“Moving among asset classes tends to be too reactive,” said Russell Kinnel, director of mutual fund research at Morningstar.

Investors in balanced and target date funds often do better because the products tend to be less volatile, making it less likely that the holder will make an emotional decision, he said.

Brokerage firms are reluctant to say their brokers shouldn't be acting as money managers.

“You can tell advisers all day long how they're underperforming, but it's human nature to think we're different, that I'm a special snow-flake,” Mr. Smith said. Twitter: @dvjamieson


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