Nadig: Rethinking Investment Performance

What the best-performing fund is may be the most expensive question in investing—especially for financial advisors.

Recently, two things came across my desk that made me think we need a radical redefinition of what "performance" means for financial advisors and their clients.

The first was the launch of Covestor's free ETF portfolios. Last week, the advisory firm waded into the model portfolio business with a set of three ETF portfolios which, with a minimum of $10,000, they will manage for free.

The second was two pieces of research from State Street Global Advisors, one on how advisors and clients see each other, the second proposing a personalized model of performance analysis drawn from the sovereign wealth fund world.

Both of these suggest we're living in an odd, odd world. It's a world in which there's not only a disconnect between where investors are finding and perceiving value, but a disconnect between investor expectations of what they can get from an advisor, and how the real world works.

Let's start with the Covestor announcement.

I'm all about people seeing how easy it is to build a low-cost ETF portfolio. After all, Matt Hougan puts one together every year and spends the rest of the year crowing about it. The issue is simply one of caveat emptor.

If someone is reading Matt's blog, they're going through a reasonable amount of due diligence. He writes at length about the exposures you're getting, the risks you're taking, and the fact that this is a back-of-the-envelope straw man, not actual investment advice.

In Covestor's case, it's a little less clear. The firm's "Moderate" portfolio consists of five well-run, cheap ETFs from BlackRock and Vanguard. It scores a "2" on Covestor's 5-point risk scale, suggesting it's almost as boring as you can get.

That risk-averse portfolio ends up being 15 percent in emerging markets equity and another 14 percent in developed international equity, with a 5 percent real estate kicker. That puts it surprisingly in line with Matt's take on what "aggressive" means.

Beginning to see the problem?

Putting together a diversified portfolio for pennies is almost literally child's play. I've taught my children's elementary school classmates how to do it, and these are kids who are mostly preoccupied with when we might get llamas into space. The rocket science isn't the portfolio construction; it's understanding what an individual investor actually needs.

Which gets me to the second set of emails from State Street. When asked what they were most looking for, here's what clients said:

Everyone wants performance. Advice? Not so much. When then immediately asked where they thought their current providers failed them?

Surprise! Performance is the thing they want, and the thing they're most unhappy about.

The connection to me here is pretty obvious. The ETF industry—and specifically ETF-focused advisors—need to get much better about communicating their real value-add. While I salute the fire-and-forget simplicity of both Matt's and Covestor's free portfolios, the reality is that those portfolios are really just scratching the surface of what most investors need.

What investors need is someone to sit down with them and actually map out the big picture. What are your real liabilities? How are you going to handle the unexpected? What are your real, rational expectations for retirement? Are you going to sell your house?

In short, they really do need unbiased, high-quality advice.

Portfolio management used to be the hard part. Thanks to the ETF revolution, it's now the easy part. The advent of firms like Betterment and Wealthfront and Covestor and—lord help us—the Hougan portfolio take it from just easy to practically free.

But just because something is free doesn't make it right for everyone. In fact, it almost guarantees it's not perfect for anyone.

Contact Dave Nadig at [email protected].