Robert Martorana's  Instablog

 

On October 1 Barclays Wealth Management in the Americas launched eight ETF-based portfolios for clients with assets of $10 million or more. The portfolios will allow large clients to open small, diversified accounts, perhaps for their grandchildren.

 

This small change continues the shift in wealth management towards low-fee, passive products. Although Barclays will actively manage the asset allocation mix, these portfolios will have lower fees, so the development is bearish for banks with large wealth management businesses. Shareholders of Citigroup (C) and Bank of America (BAC), take note.

 

Costs are lower with the new mix: After HSBC (HBC) launched a similar effort, their asset management fees dropped to 25 basis points from a range of 50-100 basis points. That's a big hit to revenue.

 

Will passive funds become a mainstream vehicle for the super rich? Last week Barron's offered an ETF special report on ETFs and the ways that investors are using them. ETFs fit well into a "core and satellite, though wealth managers differ in whether or not ETFs should form the core or the satellite. The difference in investment philosophy often reflects their existing business model.

 

Indeed, compensation for wealth managers is often the driving force behind investment recommendations. Firms have deep vested interests in their fee structures, and in the product mixes that naturally result. Most firms decry passive management and tactical asset allocation, which I have discussed in detail: "How Tactical Asset Allocation Will Transform Wealth Management". 

 

Addressing the Inevitable

The move by Barclays (BCS) acknowledges the inevitable, albeit in a small way. (These portfolios are a first step, since they are aimed at a sub-set of client wealth, rather than their core assets.) ETFs allow high-net-worth customers to execute increasingly complex strategies at the lowest possible cost, and also offer far greater transparency and tax efficiency. By using ETFs in an asset allocation product, the clients at Barclays are paying primarily for asset allocation advice, rather than for fund manager selection. Thus, an ETF asset-allocation basket would minimize the layering of fees that clients find so problematic. This product by Barclays addresses a frequent complaint of clients: Why am I paying an asset management fees of 50 to 100 basis points when my wealth manager has outsourced all of the money management to a third party?

Core and Satellite
This offering by Barclays does not mean that high-net-worth clients are not seeking alpha, or that clients are unwilling to pay for performance. Far from it. Instead, clients want to get market exposure at the lowest possible cost, which can be done via passive strategies. ETF portfolios could be complemented by alternative assets and mutual funds (using only a select few managers who demonstrate consistently high risk-adjusted alpha). I believe that ETFs will eventually become a default choice for basic asset allocation purposes, while actively managed funds will be the "icing on the cake."

 

Barclays would be wise to position the new ETF portfolios as part of a "core-and-satellite" approach. An ETF portfolio entails minimal compliance costs, and Barclays already does asset allocation research. Thus, the firm could spread their existing research costs over a larger asset base, and offer this product for as little as 20 basis points. Although the fees are lower, since the research and compliance costs are minimal, margins could still be quite attractive. (A passive "core" strategy would also allow the financial advisor and the client to focus on the "satellite" portion of the portfolio, where alpha generation occurs.) I can see the talking points now:  "Pay just 20 basis points for an ETF core portfolio, and pay 1% for a satellite portfolio of alternative assets."

 

Paying for Alpha

This shift embraces the inevitable reduction in fees, but does not throw in the towel on active asset management. Indeed, by combining ETFs with the firm's asset allocation strategy, Barclays can turn the abstract realm of global asset allocation into a concrete, actionable product. In addition, the firm has a high profile in the ETF business, due to the iShares business they are selling to BlackRock. If Barclays plays its cards right, these ETF portfolios could be a blockbuster, and not just because of low fees.

ETFs and Volatility

After a year of unprecedented market volatility, clients place a higher value on liquidity than ever before. ETFs are priced intra-day and do not have penalties for early redemptions, unlike mutual funds. ETFs do not "lock-in" a client to any given strategy, and the asset allocation can be tactically adjusted quite rapidly. This makes them ideal vehicles for tactical asset allocation.   

In order to be truly successful, Barclays must be willing to use ETFs from any provider. Now that Barclays is selling their iShares business to Blackrock, the firm should be free from any conflict of interest when choosing passive products. Thus, they can execute their asset allocation strategy strictly for the benefit of their high-net-worth clients. (Easier said than done! Conflicts of interest are rife in the wealth management industry.)

 

All in all, the launch of these portfolios at Barclays continues to move wealth management away from high-priced bundled offerings towards passive products that entail lower fees. By shifting the focus to active asset allocation, firms like Barlays are turning passive, low-fee lemons into actively managed lemonade.

Disclosure: No position in stocks mentioned. Although I worked at Barclays in the 1990s, I have no ties to the firm or to any ETF provider.

 

 

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Stocks have come a long way since March on thin volume, and despite lousy earnings quality. The lack of organic revenue growth has been irrelevent, since this rally has been liquidity driven. The lack of fundamental support has left many investors waiting for a pullback, and patiently waiting for something to prick the Mother of All Asset Bubbles (also known as the U.S. equity market).

Monday's market action offered a catalyst: Stocks fell despite bullish news about global manufacturing. When stocks drop on good news, the stage is set for a bearish reversal. Throw in the fear of an October meltdown, and the time is right for a 10% retracement. Today I trimmed my position in stocks, which was already underweight.

Meanwhile, I started to build a position in USO. Oil has been in a trading range for months despite MUCH better fundamentals for global demand. Monday's manufacturing data confirm that an economic recovery is underway, thanks to monetary and fiscal stimulus across the globe. Energy is a great play on a reflation rally, and oil can rise despite a jobless U.S. recovery and rising defaults at banks. I describe how this might play out in The Deflation of the American Dream.


Disclosure: Long IVV, USO.
 

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As Dr. Leeb articulated so well today, emerging markets are displacing the U.S. as the engine of global commodity prices. The U.S., meanwhile, has a long way to go to clean up its debt-laden economy. In the short run, this is deflationary, since deleveraging by banks and by consumers is offsetting cheap money from the Fed. This is leading to slow GDP growth, falling home prices, and stubbornly high unemployment.

But massive fiscal and monetary stimuli mean that inflation relief won't last, and will also lead to a weaker U.S, dollar. Investors can protect their portfolios from these outcomes with the nine ETFs noted at the bottom of this article. I am watching them for signals about inflation and the economy, and I have an eye on both trading and long-term portfolio protection. As for me, I am overweight cash, underweight stocks, and long gold and TIPS.


TIPS Are Sole Winner This Week
The only bets that have been working over the last week are TIPS and WIPS. (These are inflation-protected bonds in the U.S. and abroad.) Since August 12, TIP is up 0.6% while WIP is flat. These investments have consistently acted defensively against inflation, while other inflation-hedging vehicles have not.


Dollar Defies Gravity
The DBN is a bearish bet on the U.S. dollar, and it is off only slightly this week. The dollar continues to hold up well despite massive fiscal deficits and cheap money from the Fed. These are stoking concerns about the long-term decline of the greenback, but it is too soon to ride this train. Why? The Fed has defended Treasurys with remarkable vigor, and I believe that they will pull out all stops to defend the dollar. It won't succeed in the long-run, but it is dangerous to fight the Fed these days (as I note below, in my discussion of bonds).


Commodities Are Riding the Market
The major stock market indices are off 2%-3% during the last four trading days, and commodities are down even more. Oil (as represented by USO) and basic materials (IYM) are both off 4.9%, about twice the decline of stocks. Although I believe that oil and commodities are a good long-term hedge against inflation, in the short run they trade with stocks. Likewise for precious metals, which are down  a more modest 1% to 3%.

Why are commodities mirroring stocks? We are in a liquidity boom that is creating the Mother of All Asset Bubbles, and which tends to push correlations together for all risk assets. The global reflation rally is concentrated in commodites, since these are the clearest beneficiaries of rising global GDP. That's one of the reasons that I've noted that gold isn't tracking inflation as well as oil and TIPs. In fact, gold is not trading on inflation/reflation lately; instead, investors are looking to gold as a hedge against financial catashtrophe.


Bonds: Too Soon to Go Short
As David Fry noted today, it's hard to fade bonds, even though this seems like a logical trade. This is because the Fed is supporting Treasury auctions through quantitative easing. This is inflating the bid/cover ratio, so Fed purchases are making these auctions a "success" in the eyes of many market observers. Kudos go to Zero Hedge for highlighting this issue repeatedly.
Therefore, even though I'd like to short bonds by purchasing TBT, there's no sense fighting the Fed. The TBT is down 6.4% since last Wednesday, making it the worst performer in my inflation basket. It's too early for this trade, and being early is the same as being wrong.  (Though being early seems to be intellectually satisfying for certain value investors.)

Defensive Stocks Make Sense, Too
I am underweight stocks because I believe that investors are overlooking bearish signals from second quarter earnings. The reflation rally has been lifting all boats, especially assets with high risk, stocks with high betas, and companies with high operating leverage. The market is ahead of itself, so it's time to be defensive.

In fact, defensive stocks with pricing power make sense during a reflationary/inflationary period. Warren Buffet has mentioned this as an inflation hedge, especially if dividend yields are attractive.

Last week I highlighted five stocks in two defensive sectors, Healthcare and Tobacco. All four stocks are favorably rated by Zacks for strong trends in earnings revisions. The stocks are Amgen (AMGN), Intuitive Surgical (ISRG), McKesson (MCK), Reynolds America (RAI), and Altria (MO).  Altria was downgraded on the day I published the article, so that brings us to four stocks.

Not surprisingly, the two high beta stocks did the worst over the last week, with AMGN and ISRG down 4% each. The tobacco stocks were down less than 1%, and MCK was up 0.4%. McKesson and its peers in medical information are holding up well:  Perhaps as investors are finally putting a premium on defensive growth during the latest market pullback.

Symbol	Name	Price  8/17	Gain/Loss since 8/12
GLD	Gold	91.61	- 1.44%
DBP	Precious Metals	32.08	- 2.02%
TIP	Treasury Inflation Protected Securities	100.90	+ 0.58%
WIP	Int'l Inflation Protected Bonds	54.00	--
TBT	2x Short 20-yr+ U.S. Bonds	48.85	-6.42%
USO	Oil : WTI Cash	35.52	-4.90%
DBC	Commodity Basket: Egy, Metals, Ag	22.36	-2.99%
IYM	Basic Materials	48.63	-4.85%
UDN	Dollar Bearish Index	27.06	- 0.59%
SPY	S&P 500	98.31	-2.47%
QQQQ	Nasdaq	38.48	-3.49%
DIA	Dow Jones Industial Index	91.611	-2.30%

Disclosure: Long SPY, GLD, TIP

A rising tide lifts all  boats, and the current liquidity boom is boosting inflation-hedge vehicles of every stripe. The nine ETFs below are common forms of protection against inflation, and/or a crash in the U.S. dollar. Every ETF is above its 200-day moving average, and all but the TIP are above the 50-day MAVG as well. 

Approaching 52-Week Highs
Gold and precious metals are within striking distance of their 52-week highs, as are inflation protected funds of either U.S. or international bonds. Commodities are all a long way from their highs of last summer, and the short-bond index is well below its highs last Fall. 

Protection At a Cost
A basket of the securities below provide a good hedge against a devaluation in the U.S. dollar caused by rising inflation. This is a long-term bet, so I wouldn't be put off by the recent strength in these ETFs.


 

Symbol	Name	Price 8/12/09	% Change	% from 200-day Moving Avg	% from 50-day MAVG	% from 52-week  Low	% from 52-week High
GLD	SPDR GOLD SHARES	92.95	0.17%	1.87%	0.87%	40.83%	-6.10%
DBP	PWRSHS DB PRECIOUS METALS	32.7399	0.43%	2.60%	1.98%	36.53%	-7.72%
TIP	ISHARES TREASURY INFLATION PROTECTED SECURITIES	100.32	-0.39%	0.03%	-0.27%	19.23%	-6.25%
WIP	SPDR DB INTL GOVT INFLATION PROTECTED BONDS	54.00	0.80%	10.59%	2.14%	27.54%	-8.52%
TBT	PROSHS INVERSE 20-YEAR U.S. TREASURY INDEX	52.20	2.35%	5.58%	1.22%	47.00%	-24.18%
USO	U.S. OIL FUND ETF	37.35	1.33%	17.01%	4.44%	64.25%	-62.10%
DBC	DB COMMODITY INDEX	23.05	0.52%	8.87%	3.23%	28.48%	-42.53%
IYM	ISHARE DJ BASIC MATERIALS	51.11	1.15%	26.31%	11.46%	81.43%	-33.19%
UDN	PWRSHS DB US DOLLAR BEARISH INDEX FUND	27.22	0.44%	5.08%	0.73%	12.99%	-7.32%
SPY	S&P DEP RECEIPTS	100.80	1.07%	15.54%	6.39%	50.22%	-22.88%
QQQQ	PowerShares Exchange-Traded Fund	39.87	1.55%	19.22%	6.02%	59.16%	-17.91%
DIA	DIAMONDS TRUST SER 1	93.768	1.28%	14.63%	6.83%	44.75%	-20.54%

Disclosure: Long GLD, TIP, SPY