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Rick Ferri: Managing The Biggest Risk Of All

Rick Ferri: Managing The Biggest Risk Of All

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Rick Ferri is the founder and CEO of Portfolio Solutions, an index-focused investment advisory firm with more than $750 million in assets under management. He spoke recently with IndexUniverse.com Editor Matt Hougan about how to build a basic portfolio, how to choose a good financial adviser and how to truly gauge your tolerance for risk.

 

IndexUniverse.com (IU.com): It’s been a tumultuous year. How have the events of the past 12 months changed how you approach the market?

Rick Ferri, Portfolio Solutions (Ferri): The only thing that’s changed over the past year is how we talk with investors about risk.

We lost a few clients last year, not because of our strategy, but because they hit their “limit.” It wasn’t many clients—about 30 out of 500—but they just called up and liquidated their accounts.

When we asked them why, they told us that they just couldn’t take it anymore. They had had all they could handle and were selling out. What’s unfortunate is that they were selling out at the worst possible time.

IU.com: So how do you approach it now?

Ferri: We’re trying to better understand people’s tolerance for risk.

Everyone should have taken a risk tolerance test on March 9, 2009. When the markets are going up, everyone is brave. They will lie about how much risk they can really handle.

We’re now asking our clients: What did you do in 2008? What did you do during the tech bubble?

We’re stressing that, regardless of your asset allocation, let’s make sure you do not exceed your tolerance for risk.

IU.com: Do you think some of the “new” asset classes that are attracting attention right now, such as currency or international bonds, can help investors manage risk?

Ferri: We take our currency risk by buying unhedged international equities. You get free currency diversification that way. We are not doing a straight currency overlay or taking on additional currency risk. I don’t think you need to.

As far as international bonds, I look at those all the time. I look and look and look and look, and I think, “Give me a real good reason to own these.”

I know the yield is one thing, but what are you really getting? Currency diversification? It’s an awfully high price to pay for currency exposure. If you could invest in international bonds with no expense ratio or tax consequences, they might make sense, but you can’t do that.

At least for the time being, we’re not going that direction. I don’t see the need and I don’t want to pay the fees they are charging for those products.

IU.com: Do you ever look outside of index funds and ETFs? Are there any areas of the market where you see the need for new index funds or ETFs?

Ferri: There are a few funds we use that are not index funds. We use the Vanguard High-Yield Corporate Fund (VWEHX) for high-yield bonds. The high-yield bond indexes are not diversified enough and they have liquidity issues. I don’t honestly think there’s any way to index high-yield bonds. You can come close, which is what Vanguard’s fund does, so we use it as a closet BB-rated index fund.

The other area is muni bonds. We haven’t used any of the muni bond ETFs because, again, they have liquidity problems. The way to get around those liquidity problems is with cash creations and redemptions, but even then, you run into the issue of how many securities they hold in the ETF. Vanguard’s muni bond fund has hundreds of securities and charges 0.09 percent in expenses. Why would you use an ETF that charges three times as much and only holds 25 or 50 bonds? All our bond funds are open-end funds. We don’t use any bond ETFs.

Beyond that, we use a DFA [Dimensional Fund Advisers] fund in emerging market equities because it gives us exposure to both value and small caps. Emerging markets are a small part of our portfolio.

 

 

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