Tactical Managed Portfolio Strategies on the Radar

Andrew Gogerty: Advisor considerations for tactical ETF portfolios.

Hi. I am Andrew Gogerty, ETF Managed Portfolio Strategist with Morningstar. Joining me today is Neil Peplinski, Managing Partner of Good Harbor Financial, here in Chicago.

Neil, thank you for joining me.

Neil Peplinski: Thanks for having me, Andrew.

Gogerty: ETF managed portfolios: the growth is out, the story is out. Last 18 months, these strategies have seen tremendous asset growth, and interest from advisors.

A lot of the growth is definitely going towards strategies that have a significant tactical component, such as your U.S. tactical strategy.

What is it that you are seeing that advisors are wanting or demanding recently that has really put these strategies on advisors' radars?

Peplinski: I think actually the demand that we're seeing over the last 18 months is really the result of client demand that really started right after the 2008 timeframe. What we really saw were ultimately clients, they went through a fairly traumatic market environment for the second time in a decade, and that started to at least put some questions around buy and hold, and maybe shaking their confidence a little bit, and that flows up. So, I think the client demand--they started going to their advisors and saying is there another way, is there something else that we should be doing with our portfolio?

And from there, if you are working with advisors, say, in an intermediary channel, there's a time lag in terms of the companies looking for, accepting tactical, then finding their managers and then ultimately putting them on the platform and making them accessible for the advisors.

So, I think a lot of the demand really hasn't been in the last 18 months, it's been over the last three or four years, and now we're just seeing that process catch up where the availability is there.

Gogerty: You had mentioned something new, and tactical ability inside one fund or say strategy is something that advisors really haven't had access to historically with traditional mutual funds and that distribution channel.

What are some of the considerations that you are out talking to advisors about, or that you think are key for maybe a historical wrap manager now looking at an ETF managed account with a tactical component?

Peplinski: There are certainly some tactical mutual funds out there; that's the good news. They generally tend to be based on SMA [separately managed account] advisors that have been looking to expand their distribution channel, maybe make it accessible to the smaller investor.

So, the SMA side, that's what we do with our business; it's been very successful. I think one of things that's great about SMA is, especially if we find advisors that are used to them or maybe advisors that are new to them, is the transparency; certainly, over a mutual fund, it's a great advantage. Clients ultimately own the account, and they can see any move that's taken in there. So, I think that was pretty big, particularly post '08, when we saw a lack of appetite for hedge funds. We saw that be replaced by the transparency of the SMA.

So, kind of coincident with that, the increase in demand for the tactical or the alternative approach, the SMAs saw that same benefit. Obviously one of the drawbacks to the SMA is generally there's a higher account minimum, so sometimes that can put it out of reach of maybe smaller investors, and that's where the tactical mutual funds kind of step in and fill in the gap. But ... the liquidity and the transparency is really big, and advisors are seeing that, and that's really starting to benefit.

Gogerty: ... Everyone always says, know what you own, and when you own the account, you have the ability to actually see that on a daily basis as opposed to quarterly with a 60-day lag potential?

Peplinski: Right. I think one of the other advantages of the SMA as well is, because of that transparency, because clients do know what they own on any given day, when you talk about strategies like tactical that are maybe a little newer, and people are still trying to get their comfort level around them, even though we don't necessarily advocate this as an investment manager, it does give a release valve for a client. It becomes much more difficult for a manager to wander away from his mandate, because you see everything, and then ultimately if the client does see activity in that approach that they're just uncomfortable with, even if it's within the manager's mandate, they know they can always just liquidate and take their accounts. So, I think there's some great benefits from the end client's perspective.

Gogerty How is the education with advisors going? You mentioned, yes, there are tactical mutual funds, but they are by far not the mainstream mutual fund right now. In terms of that education process, obviously, Good Harbor's had tremendous success in distribution across different platforms, and even across different firms. How are those education conversations going--because some people equate tactical to market-timing, which we know is not a one-to-one corollary. There's a fundamental basis for what you're doing.

How is that education going? Or what are you keying on with maybe someone who's new to the tactical space?

Peplinski: I think many people are new to the tactical space, and it definitely is an interesting educational story that we have to tell. I will say, though, one of the unique things we've seen--and this really has happened over the last 18 months I would say--is when we first started even taking our story out after 2008, we had to spent a fair amount of time talking about the merits of a tactical management approach, and why you would want to consider it, and whether there might be some benefits over say a traditional buy-and-hold.

What we've seen over the last 18 months now is, many times we'll sit down across the table from an advisor, and the advisor will say look, I already know I want tactical, I get tactical, my clients are asking for tactical. So, I went on a search for tactical managers, and I found you, and that's why we're having this conversation. So tell me about your process and your methodology.

So, before we would spend a fair amount of time talking about the merits of tactical; now we're able to kind of shorten that up and move right into our specific process and our methodology.

The interesting part there, though, and one of the things that we [are] pretty adamant ... about upfront is, when we talk about buy-and-hold, everybody knows what we're talking about. But when we say tactical that definition can be very much idiosyncratic. You can take a handful of tactical mangers, and they're going to just have different approaches, even though they're all labeled as tactical.

So, in our educational process, the first [thing] is just to talk about what it means to us to be tactical, and that really is step one in ultimately just aligning expectations. From there, a firm like us, we've had a pretty decent track record, and so we actually spend a lot of time not focusing on performance, but really focusing on where are the risks, where might you see our tactical strategy not be quite as effective, or what environments will we do well and what environments will we not do well. So, it really becomes managing the overall expectations so you end up with a long-term relationship with an advisor and their clients, versus something that's more short-term.

Gogerty: One of the other things you had brought up--setting expectations in market environment. Because tactical is somewhat new, let's discuss. Markets recently have been volatile, yet somewhat directionless from time to time. There's really no trend or sustainable momentum up or down recently. What are things that advisors should keep in mind when someone is implementing a tactical strategy through the type of market environment that we've had recently, over, say, the last 6 to 12 months?

Peplinski: I think this gets back to some of the comments that we were making just a second ago that, ultimately, no strategy, no matter what, is going to be able to perform well in all market environments. Every strategy is going to have some market conditions where it's going to underperform, and I think a good investment management firm will put that forth, and they'll say, this is our approach, this is where we think it adds value, but these are the cases where you might not see that, where you might see us underperform. And you have to communicate that message, so that ultimately advisors and clients can understand where that is.

When we're in sideways-moving markets like this, whether any manager's particular strategy does well in an environment like this or doesn't, it will be again very much specific to that investment strategy. You'll find some tactical approaches that do well in the kind of range-bound, volatile markets; you'll find other tactical components that tend to do well when the markets are breaking off in either direction, up or down.

So, fundamentally, what the advisor and the clients need to do is, they need to understand what kind of strategy they have, and sometimes, that's actually a great argument why you would want to consider multiple tactical managers, because some approaches will work well in sideways markets, and other ones will work better in the more trending markets, again, in either direction.

So, a lot of that, I think, is where the advisor has to really dig into that and understand what kind of strategy they're getting, and maybe not get too focused on the numbers; make sure they're solid, but make sure you understand their process and their performance. And that's where we spend a lot of our time when we're giving our pitches; it's really about, what is the methodology, is there a chance that it can be consistent, how do things look, what's the likelihood that it works going forward.

Gogerty: It seems like, when you get to that point, then you're running more parallel to historical investments, such as mutual funds, where if you set the expectation, you're going to build that longer-term relationship with the advisor and ultimately the end client.

Peplinski: Right. I think in the long run, it does come down to performance. You can't neglect a poor-performing manager or strategy for too long, but oftentimes in this industry, it is pretty prevalent that there's hot money, and people will try to chase the top performer or last month's top performer, and I think that usually does a lot of injustice to a portfolio. What you really want to do is understand the manager.

If they go into a prolonged period of underperformance, then you can re-evaluate their strategy, their methodology. Again, back to the benefits of an SMA--you can see, are they wandering away from their mandate, if they changed their style. If they haven't, maybe there's no reason to abandon them yet; maybe it's just a prolonged stretch of market conditions where an approach like this being used would underperform.

But I think, again, that's the part you need to be conscious of, and ultimately, the performance. You've got to deliver at some point but...

Gogerty: ... you do.

Peplinski: …but understanding the methodology and the process will help you assess whether or not it's time to bail.

Gogerty: Thank you very much for your insight today. I appreciate it.

This has been Andrew Gogerty with Morningstar talking with Neil Peplinski from Good Harbor Financial.

For more information on ETF managed portfolios, check out our managed portfolio center on MorningstarAdvisor.com. Also take a look at our agenda for this year's Morningstar ETF Invest Conference. We've expanded the conference this year to include a dedicated track of panels to ETF-managed portfolio strategists with discussions around strategy, portfolio allocation, and implementation.

Thank you for joining us.