Wealthfront cutting costs on its risk parity mutual fund

The digital adviser says it's moved $500 million over to first proprietary fund, enabling it to halve the expense ratio

Apr 18, 2018 @ 1:00 pm

By Ryan W. Neal

Wealthfront Inc. is cutting costs on its proprietary mutual fund, less than two months after the fund was first announced.

The digital adviser said Wednesday that it had transferred $500 million of client assets into the mutual fund, making it affordable to halve the expense ratio from 0.5% to 0.25%.

Wealthfront co-founder and CEO Andy Rachleff said the move was inspired by Vanguard.

"We've always admired the way Vanguard slashes expense ratios as their products scale because we believe it's the right thing to do, and we aim to share our success with our clients in the same way," Mr. Rachleff said in a statement.

The company uses the fund to offer a risk parity strategy, which equalizes the risk contributions of asset classes within a portfolio rather than allocate based on risk-adjusted return expectations. Wealthfront said risk parity can achieve higher absolute and risk-adjusted returns, and in March it announced that it would move a portion of taxable accounts with at least $100,000 invested into the strategy (while giving investors the ability to opt out).

Some clients objected to the 0.5% expense ratio because it was more expensive than the ETFs they are accustomed to using. The price reduction makes the mutual fund's expense ratio "lower than nearly 80% of ETFs on the market," Mr. Rachleff said.

When the strategy was announced, some said the fund's expense ratio didn't tell the whole story. Meb Faber, chief investment officer at Cambria Investment Management, said on Twitter that the expense ratio didn't include the cost of total return swaps.

(More: Wealthfront valuation reportedly slashed by about a third in most-recent funding round)

According to Wealthfront's white paper, the risk parity strategy assumes an addition 0.75% in costs, meaning the total cost to investors following the expense ratio reduction is 1%.

The Wealthfront spokesperson said that there are costs associated with implementing every investment strategy and that adding the cost of operating a fund to the expense ratio is a misrepresentation. The spokesperson added that the projected cost of the fund is clearly laid out in the white paper.

Micah Hauptman, financial services counsel at Consumer Federation of America, acknowledged that every strategy has operational costs, but disagreed that implementation through an ETF could be considered on par with implementing through a total return swap.

"Even by their assumption in their white paper, it's the cost of one-month Treasuries plus 75 bps," Mr. Hauptman said. "So the expected benefits would have to be pretty significant to outweigh these costs."

Wealthfront believes they will be, and says the data will reflect that after the fund has been allowed to operate for some time. The spokesperson also said that Wealthfront is a fiduciary, and any strategy it introduces would have to be in clients' best interest.

This is why the company didn't immediately roll assets into the mutual fund. The spokesperson said Wealthfront used its algorithms to ensure assets are moved tax-efficiently, and informed some clients that risk parity isn't appropriate for them because they would incur too large of a tax penalty.

The process has been slow and deliberate, and the company expects to have $1 billion in the fund following the transition.

(More: It may be too early to write off robo start-ups)

Mr. Hauptman said this is a good sign from Wealthfront, but he still has reservations about defaulting to investors to risk parity rather than asking them to opt in.

Some experts in risk parity strategies said they approve of Wealthfront making this strategy available to mass affluent investors. Rodrigo Gordillo, a managing partner and portfolio manager at ReSolve Asset Management, said risk parity provides Wealthfront with a more diversified, global portfolio that will be more resilient than traditional 60/40 portfolios.

Mr. Gordillo said the use of total return swaps is a fairly common practice and there is nothing nefarious in how Wealthfront is using them, but he said the company could be more transparent in its prospectus about the costs of underlying funds.

He also wondered whether Wealthfront's investment team is equipped to manage the complexity involved with risk parity.

"While the theory of the strategy is described effectively with mathematics, there are many dimensions of the strategy that would certainly benefit from wisdom and experience," Mr. Gordillo said. "I'm surprised Wealthfront did not seek a sub-advisor relationship with an experienced risk parity manager, with an option to take over the strategy after a few years. I think clients may have felt more comfortable with this deployment strategy."


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