[This article originally appeared in our July issue of ETF Report.]
As The Notorious B.I.G. once said, "mo' money, mo' problems."
High net worth clients have unique challenges in their portfolios, including the balancing act of keeping costs low and returns high, while also minimizing one's tax footprint. That's where ETFs, which tend to be inexpensive and tax efficient, can make a measurable difference.
Since 1998, Miller Investment Management has dedicated itself to serving, among others, the needs of high net worth families. Miller has used ETFs in client portfolios since 2001, citing their tax efficiency and lower expenses over mutual funds. "Their low cost is primary to us," says partner Wyn Evans.
Recently, ETF Report sat down with Evans to learn more about how the firm uses ETFs for high net worth clients.
What sets Miller Investment apart from its competitors?
I'd say our secret sauce is our Investment Strategy Committee, which meets every two weeks. The people on the committee bring diverse backgrounds to the table.
For example, a lot of our clients are taxable—basically, high net wealth families—so wealth transfer and taxation become an issue. One of the committee members, Richard Rosen, is a trusts and estates attorney. Another, Bob Peck, used to manage money for Ross Perot and the Murchisons; now he runs his own hedge fund. Ditto Paul Isaac, who runs Arbiter Partners, a long/short hedge fund that has an outstanding record. Paul Miller was one of the founding partners of the very successful firm Miller Anderson & Sherrerd, which was sold to Morgan Stanley. Larry Chimerine, our economist, used to run Chase Econometrics.
Sounds like you've got a lot of smart minds on deck.
Exactly. They're our idea generators. They're the ones who say, "Maybe you ought to take a position there," or "You ought to think about moving out of that."
Then it's our responsibility on the Portfolio Management Committee, of which I'm a part, to research those ideas and figure out how to put the plan into action. That's where ETFs come in.
How do ETFs fit into your portfolios?
Rather than buying individual securities, we almost always use pooled investment vehicles, be they ETFs, open-ended funds or closed-end funds. Every once in a while we will buy individual securities, but it's pretty rare, because we like to stay focused on the macro issues, instead of getting tied up in the weeds.
We're always struggling with how to get the best after-fee returns for our clients, and we've found that ETFs are typically lower cost than something that's actively managed. Maybe the active manager is 1%, and the ETF is 0.5%. So if you're going to use active management, the question is always: Will the active manager be able to provide enough outperformance to overcome that difference in fee?
As you might guess, in places like U.S. large-cap equities, it's difficult for them to outperform, so we tend to go more into ETFs. For example, we have a pretty big allocation to the SPDR S&P 500 ETF (SPY | A-98).
But once you start getting into sectors, sometimes it's not so difficult to find active managers who outperform. Several years ago, we decided to make a technology allocation. Vanguard has a cheap ETF product: the Vanguard Information Technology ETF (VGT | A-94). But then we looked into T. Rowe Price, and their technology funds really outperformed. So in that case, we went with the active manager. Maybe that's not what you want to hear! But it's what we did.
True; everything has its place. Do you find ETFs appealing simply on a cost level, or do you see other benefits too? How do you feel about, say, their intraday liquidity or tax efficiency?
Low cost is primary to us, but what generally doesn't enter into it at all is liquidity. As long as I can get out at the end of the day, I don't really care if I can trade in the middle of the day, because most of the stuff we buy has high liquidity anyway. For example, for most of our bond allocation, we use Vanguard funds. You can get out of them at the end of the day, and that's good enough for us.
Roughly how many ETFs do you use?
It varies over time, but right now, I would say we have about six.
You mentioned SPY earlier. What are some other ETFs you use?
We use the SPDR S&P Insurance ETF (KIE | A-71) and the iShares U.S. Home Construction ETF (ITB | A-75). In particular, ITB is a great example of how we approach ETFs. We knew we wanted some housing exposure, but we didn't want to buy individual securities: We wanted diversification, because there's too much company-specific risk. Yet there really wasn't an active manager in the space. So we went to ITB.
What are your thoughts on actively managed ETFs? Are there any you're following right now?
We do like the AdvisorShares TrimTabs Float Shrink ETF (TTFS | C-82). When we first started researching the fund, it wasn't obvious to me that it would be tax efficient, because its turnover is relatively high, but it was. Plus, its expense ratio is comparable to that of any other active manager.
Also, because of the structure of an ETF, they tend not to have to distribute many capital gains to their shareholders. Look at TTFS' history; all they've distributed is dividends, whereas if this were a typical mutual fund, there's no doubt in my mind they would've had capital gains distributions by now. We like that. Personally, I wonder why all open-ended funds don't go to an exchange-traded-fund format.
Looking ahead, what are your expectations for the second half of the year, and has that affected which ETFs you hold?
Lately we've been reducing our domestic equity allocation and moving offshore. Typically we don't use ETFs in offshore markets because they're less efficient. We feel that the less efficient a market is, the more an active manager can outperform.
As far as U.S. assets are concerned, our theme is that rates will rise, eventually, and you're probably going to see some flattening of the yield curve. Of course, I've been saying that for several years now, and it's certainly taken a long time to get there!
Given that, we tend to shy away from the high-yield equities. We've been reducing equity income funds and things like that.
Generally speaking, however, we're positive on the economy. We think the likelihood of another recession in the next year or two is very small. Or so says our crystal ball.