The Long Road: No Mirage In Phoenix

June 20, 2008

The weather's not the only part of this growing community that's hot right now. So is the local interest in ETFs and index investing.


When hotbeds of activity for exchange-traded funds are considered, the Valley of the Sun probably doesn't pop up on too many 'Top 10' lists.

But that's an oversight. The hyper-growth of ETFs is finding a lot of support among financial advisors in the fast-growing economy of Phoenix, Ariz.

A good example is David Fernandez. Five years ago, he left fund giant Vanguard to start his own firm, Wealth Engineering, in Scottsdale, Ariz.

A native of the Phoenix area, Fernandez focuses on high net worth individuals on a fee-only, no-commission basis. "We work with a few low-cost active funds, mainly from Vanguard," he says. "But we're 95% passively based in our portfolio construction."

Early in 2007, Fernandez started dropping his clients' long-term stock allocations by anywhere from 10%-20%. "We're overweighting fixed income at this point," he says. "And that's just not in the U.S. We're using a truly global strategy in both our equity and bond portfolios."

He doesn't like to churn holdings, though. Fernandez believes in tactical allocations but only in small doses and when major shifts in valuations among broad asset classes show up. In fact, last year's call was the first major shift between stock and bond allocations for his firm.

"The credit bubble is still unwinding. It's going to take a while to get all of the excess credit out of the system. We might see some minor rebounds, but this is going to be a slow, drawn-out process that might take another two to three years," Fernandez says.

He's preparing to add the Vanguard High-Yield Bond Index Fund (VWEHX) to his client portfolios. "Yields have become very attractive lately. So you're starting to get compensated better now for taking on more risk," Fernandez says.

Disciplined Rebalancing Is Key

Another Phoenix investment shop devoted to modern portfolio theory and using ETFs is Perspective Financial Services.

Every quarter, the firm's advisors meet with an investment committee that provides guidance and ideas for portfolio construction. Besides ETFs, they'll use both passively and actively managed mutual funds, with an emphasis on low-cost options in the latter category.

At the end of last year, such an approach of using a centralized investment committee helped steer Perspective's clients away from a huge Schwab ultra short-term bond fund that wound up tanking as a result of the mortgage meltdown.

Now, advisors at the firm such as Patrick Eng say they're still calming clients who are jittery about market conditions. "I'm trying to help my clients look at this current market environment as a buying opportunity rather than a dooms-day scenario," Eng says.

A big problem is that many investors confuse trading with investing, he points out. "The two aren't the same, and we keep in touch with our clients a lot about educating themselves on the differences between the two," Eng says. "We're trying to help people understand that although we've seen positive returns in stocks since 2003, it's natural to also see corrections."

When he makes changes, it's typically a result of a very systematic approach, he adds. "When we make a change, it's part of a very disciplined rebalancing strategy," Eng says.

Lately, that has been translating into putting new money into real estate investment trusts, small-caps and international stocks. Some of Eng's favorites in those asset classes are iShares Cohen & Steers Realty Majors (NYSE Arca: ICF) and iShares Russell 2000 Index (NYSE Arca: IWM).

For overseas stock exposure, Eng likes to use mutual funds by Dimensional Fund Advisors. Those include DFA International Value (DFIVX) and DFA International Small Cap Value (DISVX).

Taking A Macro View Of Markets

A name familiar to many IndexUniverse readers is longtime Arizona resident Roger Nusbaum. He's well-known nationally and one of those whiz-kid types who started following stocks at age 11. As an adult, he'd come home after work and read financial books until falling asleep.

That was before personal computers became cheap and easy to use. "Computers have just made doing research that much easier," the 42-year-old Nusbaum says.

After college, he went to work for Lehman Brothers as a broker. "But I was a pretty rotten salesman," Nusbaum says.

So he went to Schwab and worked as an institutional trader through most of the 1990s. In 2003, he decided to follow his dream of managing separate accounts by opening his own business. Within a year, he was being quoted by leading national investing publications such as Barron's. That led to an offer from Your Source Financial in Phoenix to head up its portfolio management operations.

As a result, Nusbaum builds and manages portfolios for the firm's private clients, who are serviced directly by financial advisors. "It's an ideal situation for our clients because my only responsibility is research and design of portfolios," he says. "That's the only hat I wear."


While Nusbaum shouldn't be mistaken for a portfolio churner or trader, he definitely takes a more proactive view on managing portfolios. But his strategy is long-term in nature and changes only when big macro themes suggest fundamental shifts in central parts of the market.

Nusbaum benchmarks his process to the S&P 500. He compares weightings of each of its 10 major sectors. Taking a top-down approach, his larger portfolios utilize both ETFs and individual stocks to weight sectors.

"Overdiversification can create a performance drag. So with accounts holding less than $200,000 in assets, we mainly use ETFs," Nusbaum says.

Right now, he's using ETFs to modestly over-weight: materials through iShares S&P Global Materials (NYSE Arca: MXI); utilities with iShares S&P Global Utilities (NYSE Arca: JXI); and telecom using WisdomTree International Communications (NYSE Arca: DGG).

Depending on the client, Nusbaum has between a 15%-20% stake in cash. "What we've done with fixed income is slowly but steadily increased our exposure to foreign debt," he says. "Specifically, we own Norwegian, Australian and U.K. sovereign debt."

Those are mainly individual notes. But in smaller client accounts, he's buying the SPDR Lehman International Treasury Bond ETF (AMEX: BWX).

Nusbaum describes current conditions as a "normal bear market." Historical patterns would imply about a 30% decline from peak levels, he says.

The S&P 500 peaked in mid-October 2007, Nusbaum adds. "We've lost about 14% up to this point. So we're about halfway there," he says.

Focused On Fixed Income

The Phoenix area also is home to several good bond experts in the advising world. But one who takes it a step further is Len Templeton. Based in Chandler, Ariz., he exclusively works with bond portfolios for high net worth and institutional investors.

Much of his expertise is used by other advisors across the country who are more stock-oriented. "I don't consider myself an active manager," Templeton says. "I manage tax situations for individuals. I don't make major calls on the market or move securities around. Just keeping track of taxes adds a lot of value for high net worth individuals."

He believes that bond investors with $250,000 or less to invest in bonds are probably better off buying an ETF or mutual fund. "But for larger investors with assets in taxable accounts, after-tax returns become more of a concern," he adds. "In those situations, we build customized portfolios to meet their individual tax situations."

Templeton works with many investors who live in smaller states without state-specific municipal bond funds available to them. He also finds that even for those who can take advantage of state-specific muni funds, diversification becomes a concern.

"There are a lot of new muni ETFs that've come out. But they're more long-bond strategies," Templeton notes.

Before moving to Arizona, he worked in the trust department of a large bank managing bond and money market portfolios. He also served on the institutional side of investment banking.

But after surviving Chicago winters his whole life, the now-58-year-old Templeton moved to Arizona about five years ago. "Our kids were out of college by then, so it was a good time to make a move," he said.

Charging just 25 basis points for his services, he built a fee structure that competes favorably with most bond ETFs and index funds. "About 90% of the advisors in the Phoenix area are much more equity-oriented. So I work with a lot of advisors and end up being their fixed-income guy," Templeton says.

Bonds are anything but dull, he adds. The ongoing mortgage meltdown and credit crisis is a case in point. "The whole mind-set about buying bonds is changing," Templeton says. "Today, insurers are under tremendous stress. What that means is someone needs to know what an underlying fund really holds before making an investment."

This Isn't The Only List Of Advisors

Of course, many more experienced ETF-minded advisors operate in the greater Phoenix area. As the population of this interesting and dynamic desert community keeps growing, so will the number of advisors using cutting-edge investment tools.

If you're fortunate enough to already live in the area, don't take this short list as any sort of recommendation. The point is, the field is evolving, just like ETFs. And if you look, it's very possible you'll be able to find a savvy ETF advisor who understands your approach to investing and knows how to implement it using the best tools possible.

You can also try searching for other nearby advisors through the National Association of Personal Financial Advisors. These are the folks who don't believe in commissions and only charge on an hourly basis or as a percentage of assets when managing entire portfolios. You can find their site here.

Another possibility is the Financial Planning Association. Like NAPFA, its site has a search tool to find advisors based on different sets of criteria. Unlike NAPFA, it accepts members who work on a fee-only basis or through commissions. (A lot of financial planners these days are mixing the two and offer both.) The FPA can be accessed here.

Murray Coleman is managing editor at IndexUniverse. He can be reached at: [email protected].

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