Richard Ferri is CEO of Portfolio Solutions, LLC, an investment management firm based in Troy, MI. Portfolio Solutions manages approximately $1 billion in separate accounts for high-net-worth individuals, families, non-profit organizations, and corporate pension plans. The firm specializes in a low-cost, tax-efficient, asset allocation investment approach to building wealth.
Rick has written five books on asset allocation, index funds and exchange-traded funds (ETFs). His latest book, The ETF Book: All You Need to Know About Exchange-Traded Funds, was recently published by John Wiley. Also available are Serious Money, Straight Talk about Investing for Retirement (free download), All About Index Funds [2nd Edition: McGraw-Hill], Protecting Your Wealth in Good Times and Bad [McGraw-Hill] and All About Asset Allocation [McGraw-Hill]. Ricks books have been praised by the likes of John Bogle, founder of Vanguard, Don Phillips, managing director at Morningstar, and William Bernstein, author and founder of Efficient Frontier.
Rick earned a Bachelor of Science degree in Business Administration from the University of Rhode Island and a Master of Science degree in Finance from Walsh College. He also holds the designation of Chartered Financial Analyst (CFA). Prior to joining the investment community in 1988, Rick served as an officer and jet pilot in the U.S. Marine Corps and is now retired from the Marine Corps Reserve.
Rick and I have recently been in contact via e-mail, and he agreed to answer a few questions that I thought would be of interest to readers of this site.
DR: Why did you decide to write a book about ETFs?
RF: The investment philosophy at our firm is to create efficient portfolios of low-cost index funds for our retail clientele. Since all ETFs technically follow indexes, for several years I have been studying the structure of each new ETF as it was introduced. After many years and hundreds of ETFs later, I developed a method for categorizing ETFs based on the underlying indexes they follow. I discussed this research with an editor at John Wiley & Sons in 2006, and that lead to writing The ETF Book.
DR: Who do you think will benefit from reading The ETF Book?
RF: Two types of readers will benefit the most:
Individual investors: Those who are knowledgeable about mutual fund investing but have not yet invested in ETFs, and those who have invested in ETFs and seek a deeper understand of different index methodologies and fund structures.
Financial advisors: Those who want to learn more before including ETFs in client portfolios, and those that already include ETFs in portfolios and are seeking a new way to analyze these products or more information about investment strategy.
DR: According to your book, you have decided to donate the royalties from sales of The ETF Book to the wounded heroes of this nation. What brought you to this decision?
RF: As a retired Marine Corps officer, I have the deepest respect for the men and women of the Armed Forces who unselfishly give their lives to protect our rights and freedoms. Scores of men and women have returned home from the battlefield with physical wounds that are treated by the valiant doctors and staffs at our military hospitals. The medical treatment, while healing the broken bones and lost limbs, fails to treat the all wounds inflicted upon our heroes and their families. The Wounded Heroes Foundation provides financial assistance and other services to these heroes and their families so that they can better cope with all the issues that resulted from their service to our country.
DR: What are the most significant mistakes you see investors making today?
RF: There are two, and they are related:
1) Poor investment discipline
2) Performance chasing
Over a lifetime of investing investors will discover that a market return is a great return relative to what everyone else earns. You do not need to “beat the market” to achieve your long-term financial objective. Come up with a sensible, low-cost investment plan, implement the plan, and stick to the plan.
DR: Are there times when you recommend actively managed funds over index funds?
RF: Yes. Here are three examples.
We use the actively managed Vanguard TIPS fund over TIPS index funds and ETFs. The TIPS indexes are not well built. The Treasury Department did not consult index fund investors when they issued the 21 or so TIPS on the market today. As such, a TIPS index has no rhyme or reason from an investment perspective. We would rather use the actively managed Vanguard TIPS fund because it is low cost and uses a structured investment strategy.
Another area is emerging market bonds. We use an active fund for this segment of the bond market because we want foreign currency exposure. The two emerging market bond ETFs that are listed on the market both invest in dollar denominate securities, and that means they have no foreign currency exposure. The active fund we use costs about 0.20% more than an emerging market bond ETF, and we believe the currency diversification of that fund is worth the extra cost.
We also use a few DFA value funds. DFA’s strategy brings deep value exposure in the US and international equity portion of a portfolio. To date, no index provider has been able to duplicate the deep value exposure that DFA provides in its funds. Although DFA funds are more expensive than value index funds, on cost per unit of value exposure basis, DFA funds are still less expensive.
DR: How do you investment your own money?
RF: Most of my long-term investments are in a retirement account. That account is managed exactly as we manage our portfolios that have a 70% stock and 30% bond strategy. The allocation is in my All About Asset Allocation book. All of our clients receive detailed quarterly performance reports. The reports are calculated net of all fees and expenses, which is the only way advisors should be reporting performance.
DR: Why did you start Portfolio Solutions?
RF: After more than 10 years employment at large brokerage firms, I decided to spend the rest of my working life on the clients’ side of the table rather than Wall Street’s side.
DR: What services does Portfolio Solutions offer?
RF: Our company offers only portfolio management services. Our mission is to structure and manage separate accounts for retail clients using a low-cost, efficient, asset-class based strategy. Portfolios are diversified across a broad range of index funds, exchange-traded funds (ETFs) and other low-cost investments. The framework for portfolio management is discussed in two of my books, All About Index Funds and All About Asset Allocation.
DR: How are you able to keep your management fee to only 0.25% per year?
RF: I started the company with a 0.25% per year asset management fee and have never change it. Despite our modest fee, we have maintained at least a 50% profit margin. So you can imagine how much money the 1.0% plus fee advisors are making.
Keeping overhead low is the key to profitability. That goes for any business. We only have one office and it is in Michigan were rents are low and unemployment is high. We have a very small advertising budget. Most clients come to us from word of mouth or after reading one of my books.
We have one salesman – me. All potential clients talk with me personally before I send them an application. The phone interview is a two way screening process. Not all people who contact us are a good fit for our services. We try only to work with people who are true believers in the strategy we offer and will be with us long-term.
We do a good job managing clients’ expectations. Our clients understand that we are running a buy, hold and rebalance strategy using a long-term strategic asset allocation. We don’t do hand-holding calls to clients when the markets go down, nor do we do quarterly meetings, nor are we willing to talk about whether the Fed may or may not change interest rates, nor are we interested in discussing what the talking heads on the television are predicting. If a person wants that level of hands-on management, they need to go to someone who will give them the touch-feely they need and pay a higher fee.
We have never lost a client due to portfolio performance or client service. In total, our turnover rate of clients is less than 2 percent annually, and most of the turnover occurs because some clients pass away each year. We have had to resign from a few accounts because the clients wanted us to change our strategy to conform to popular opinion at the time. We are not willing to compromise on strategy.
DR: What are some of the key factors an investor should consider when hiring a financial advisor?
RF: There are three factors:
1) Does the advisor have the same investment philosophy that you believe in?
2) Can the advisor prove with actual accounts that they have maintained their investment discipline during all market conditions?
3) What is the total cost of implementing the advisors investment strategy including advisor fees, fund expenses, commissions, and trading spreads; and is it feasible that the advisor will make up those costs in the future based on their strategy?
DR: Has the decline in the value of the dollar as compared to other major currencies had an impact on your investment strategy?
RF: No. Every portfolio holds 30% in unhedged foreign stock exposure. We use a fixed allocation to international markets, for example; Europe (40%), Pacific Rim (40%) and emerging markets (20%). Those regions are rebalanced as one region outperforms another. Fixed allocations to geographic regions has created better risk adjusted returns than using a total international fund that does not rebalance.
There is a lot of performance chasing going on and it is justified in many ways. In the late 1990s, when the dollar was much stronger, many advisors were questioning the wisdom of having any foreign stock exposure.
President Calvin Coolidge made a profound statement in the 1920s, “The business of America is business.” While we occasionally stray from that vision, we can rely on an occasional financial crisis to refocus the nation on what makes this country tick. That process is occurring as we speak.
DR: Rick, thanks for taking the time out of your busy schedule to share some of your insights with us today.