ETFs Point To A Goodbye For Style Boxes

December 08, 2014

Internet Of Things

One of the most exciting trends in technology is known as the "Internet of things," a phrase that denotes the informational connectivity of everything from household appliances, transportation modes and factory floor activities to smartphones, tablets and data centers. The little microchip has come a long way.

ETFs in some ways are analogous to microchips, as they are pointing the way to a whole new and more thoughtful way to invest that I like to call the “portfolio of things.” But I’m getting ahead of myself. So first a bit more about the Internet of things, and the reasons it’s still more of an idea than a new way of life.

The challenge for the future, like all innovation, will be rooted in the systems and regulations that will need to adapt in order to process and use all this information in productive ways. In the U.S., where average Internet download speeds are a mediocre 35th in world rankings and where a shortage of trained data and software engineers exists, solving these issues will be critical.

A policy of infrastructure investment and immigration reform focused on retaining foreign graduates of U.S. universities is required, but intransience in Washington ensures an uncertain future for the next big thing that could help transform the global economy.



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Similar Challenges For Money Managers


Asset allocation firms face a similar problem in the infrastructure that has been built up in the U.S. to serve “style box" investing styles. That infrastructure is manifested by a reliance on benchmarking, where consultants, dealers and investing platforms assign theoretical performance standards based usually on static mixes of equity, fixed income and alternatives.

The results often bear little resemblance, and even less relevance, to the funds or portfolios that are subject to the analysis. This is a travesty, since multi-asset strategies are often used to dampen overall client portfolio volatility or provide a far broader perspective of global risk and return.

In fact, on most platforms, statistics related to the evaluation of risk/return and real returns (factoring inflation) are often buried in the glossy printouts of broker and platform profiles. No wonder many advisors and their clients get trapped by recency bias when evaluating managers. Rather than focusing on the process, the plan or a client's risk preferences—it’s all about the performance of a manager in the last quarter or last year.

Regulators of mutual funds force a similarly poor outcome by requiring a fund’s primary benchmark—no matter how static in construction or poorly reflective of a fund's current allocation—to be priced daily. It's an admirable requirement from a transparency perspective, but why is it the first thing an investor or advisor sees in evaluating a mutual fund? Most investors and advisors we talk to assume the first benchmark is the most relevant.

Portfolio Of Things

This "portfolio of things" representing various asset classes is a valuable investing approach that can be sandwiched between traditional "high beta" and "capital preservation" strategies.



Understanding The Road Ahead

An advisor's job becomes easier, not more complicated, allowing far more time to devote to tax, estate and planning aspects of a client relationship. But the tools to analyze relevant risk data are not widely available where advisors actually buy funds or portfolios.

As an asset allocation firm with a credit-driven macro approach to building portfolios and funds, JAForlines highlights a range of risk statistics relative to the returns we seek. Understanding the benefits of multi-asset portfolios shouldn't be complicated because regulators and the informational technology available on dealer platforms is behind the times.

In fact, our institutional clients, like foundation and endowment investors, have long understood the need to evaluate asset allocators with multiple lenses. The favorite benchmarks for these investors have always been a risk spread over inflation or TIPS, as this gets to the notion of real and absolute returns.

The point is to have a flow of returns and income to distribute to beneficiaries on a regular basis, similar to what goes on in an IRA or a 401(k) plan, or for a pool of savings meant to distribute to heirs and charities. Regulators and dealers to date have decided that advisors servicing individual clients and plans are not capable of articulating such useful information.

Our portfolio and funds are like the "Internet of things" in that the networks in which they exist aren't ready for the reality of their value and utility in the marketplace, but some sophisticated advisors have figured this out on their own.

Ultimately, innovation in financial markets, as in all markets, will happen as clients eventually demand change.

JAForlines Global (JFG) provides investment advisory services to clients of broker dealers, their registered representatives and independent RIAs. JFG specializes in constructing actively indexed portfolios using ETFs, which are available for private wealth management investment or in qualified retirement plans via a Collective Investment Trust (CIT). Contact the firm or visit their website below at 516-609-3370 or [email protected] or



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