Sellers of Portfolios-To-Go May Become Wall Street’s Next Thundering Herd

Andy Cohen, 47, uses exchange-traded fund portfolios recommended by MarketRiders Inc. to manage his retirement plan and children’s college savings. He’s charged about $10 a month.

“I don’t have enough money that I have a dedicated wealth manager,” said Cohen, who lives in San Mateo, California, and is chief executive officer of Caring.com, which offers resources for children helping aging parents. “It got me a much more diversified portfolio than I could have ever done on my own.”

The next thundering herd on Wall Street may be the ranks of low-cost portfolio managers such as MarketRiders and Folio Investing, which cater to self-directed investors like Cohen. Sites that sell prepackaged portfolios have attracted more than $3 billion in assets over the last three years as more investors leave their full-service brokers.

“Individual investors have started to realize they can actually do some things as self-directed investors reasonably well, if they’re given a platform that allows them to invest more intelligently,” said Steven Wallman, chief executive officer of Folio Investing, where investors can purchase predesigned and customized index portfolios for $29 a month.

Some of the firms, such as Flat Fee Portfolios, are too new to have any performance history. MarketRiders can’t track the actual performance of its customers’ accounts, since it doesn’t have custody of their assets. Covestor and Wealthfront Inc., which give users access to third-party investors, publish performance history for the managers they work with on their sites.

Performance History

“Who are the people that are advising me when I’m going to a faceless website?” said Chris Walters, head of wealth management for Pasadena, California-based CitizensTrust. He said investors should be concerned by the lack of performance history available from some of the firms.

Bank of America Corp. (BAC)’s Merrill Lynch and Morgan Stanley Smith Barney, the top two full-service brokerages by client assets, had combined outflows of about $150 billion during 2009, the most recent year for which data is available, and about 10,600 financial advisers left the firms that year, according to Aite Group, a Boston-based research firm. Merrill Lynch hasn’t seen a trend of investors leaving the broker, said Selena Morris, a spokeswoman for the bank.

Change in Focus

“The number one source of accounts is what we would refer to as full-commission brokers,” said Peter Sidebottom, executive vice president of product, marketing and client experience for Omaha, Nebraska-based TD Ameritrade Holding Corp. (AMTD), which caters to do-it-yourself investors. Accounts with TD Ameritrade increased by 14 percent over the two years through December and assets are up 65 percent over the same period, to $386 billion.

Traditional brokerages are focusing more on their wealthiest clients in an effort to improve profitability, so the customers leaving these firms tend to be the ones with the smallest accounts, said Katharine Wolf, senior analyst for Cerulli Associates, a Boston-based research firm.

“They’re not looking to target a client that has, say, under $250,000 to invest,” she said.

Those investors are potential customers for services such as Flat Fee Portfolios, which began opening accounts in February. Clients with assets of less than $250,000 are offered several predesigned portfolios with an annual review for a fee of $129 a month.

It’s the “Wolfgang Puck Express” of portfolio management, said Mark Cortazzo, founder of Flat Fee Portfolios, referring to the celebrity chef who sells gourmet dishes for low prices at his fast-food restaurants. The portfolios are managed by Macro Consulting Group in Parsippany, New Jersey.

Accessible Price

“It’s for people who want good quality asset management,” at a price that is “accessible to a much wider demographic,” he said. The firm charges $199 a month and provides semiannual reviews for accounts with at least $250,000.

At Hedgeable Inc., investors can choose from among 20 different exchange-traded fund or stock model portfolios. Fees for the service, which began opening accounts through its website in December, range from 0.75 percent to 1.5 percent. Investors like the transparency of the Web-based business models, said Mike Kane, founder of the New York-based firm.

“Traditionally in the investment advisory world you hand over to your adviser say $100,000, and they invest it how they see fit. You meet with them once a quarter or once a year and you really don’t have any control beyond that,” Kane said. Hedgeable investors can view up-to-date account information including transactions and holdings on their mobile phones, he said.

E-Mail Exchange

Some of the services leave investors in control of their assets and others take discretionary authority over client accounts. With Flat Fee Portfolios, managers have discretion over client assets. MarketRiders gives advice on investment decisions, such as rebalancing, and investors may then choose whether to apply it to their own brokerage accounts. Other than Folio Investing, which is a broker-dealer, all of the firms are registered with the U.S. Securities and Exchange Commission as investment advisers.

“The beauty of it for me is that monthly e-mail that just says ‘Here’s how to do it,’” said Cohen, who has been using MarketRiders for about two years. “If I didn’t get that e-mail I’d never do it.”

Prepackaged portfolios from Folio Investing may contain individual stocks, mutual funds or exchange-traded funds. The McLean, Virginia-based company’s moderate portfolio for investors planning on retiring in 2040 is composed of 10 exchange-traded funds and notes that track stocks, real-estate investment trusts and commodities, including the PowerShares QQQ fund, which follows the Nasdaq-100 stock index.

Viewable Actions

That portfolio returned 3 percent annualized over the three years to April 6, compared with average returns of 1.3 percent for 2040 target-date mutual funds, according to Folio Investing and data from Chicago-based research firm Morningstar Inc.

Covestor, which began managing money in November 2009, tracks the portfolios of about 30,000 users who choose to make their investment actions viewable to others on the site, and users may have their accounts track the trades of about 150 pre- screened managers on the site.

“It’s like an open-source hedge fund,” said Perry Blacher, chief executive officer of London-based Covestor. Some of the managers on the Covestor site are professional investment advisers registered with the SEC and some aren’t. The managers range from Atlas Capital Advisors, a San Francisco-based registered investment adviser that manages $175 million for high-net-worth investors, to “an ophthalmologist in Wisconsin,” Blacher said.

Global Reach

“Investors should always be very careful to check out the people providing investment advice,” said Patricia Struck, administrator for the division of securities of the Wisconsin Department of Financial Institutions, “especially when what they’re giving you is not tailored to your needs.” SEC spokeswoman Florence Harmon declined to comment on the Covestor business model.

These sites don’t represent a competitive threat to traditional brokerages, said Jim Wiggins, a spokesman for Morgan Stanley (MS) Smith Barney.

“People don’t come to Morgan Stanley Smith Barney for discount trading,” he said. “They come for professional money management and to access some of the products and services that are only available through a global investment bank.” He declined to provide the range of fees full-service brokerage customers pay.

‘Cookie-Cutter Approach’

MarketRiders, based in Palo Alto, California, has $2.7 billion in user portfolios. Traditional brokerages had about $4.7 trillion in assets under management at the end of 2009 and account for about 38 percent of all U.S. wealth-management assets, according to Aite data. Folio Investing, which is closely held, has “multiple billions” invested, said Wallman, who wouldn’t provide a specific figure. Covestor’s Blacher, who wouldn’t disclose assets, said the company is gaining about 15 percent in assets each month.

“I have yet to see a cookie-cutter approach that is as appropriate as a customized approach, and that’s what you give up when you go to one of these types of services,” said Walters of CitizensTrust, which is the wealth-management division of Ontario, California-based Citizens Business Bank. Walters’s firm has an average client account size of $4 million.

Mass Management

Wealthfront, which started in October 2009, lets users invest as little as $10,000 among 40 different registered investment advisers who normally have account minimums of $1 million. The firm has about $180 million in assets invested through its site.

“We’re trying to deliver institutional-class asset management to the masses,” said Andy Rachleff, chief executive officer of Palo Alto, California-based Wealthfront. He said the firm chooses investment managers to participate the same way endowments do, by examining managers’ historical trade details rather than just their performance history. Rachleff is the vice chairman of the University of Pennsylvania’s endowment investment committee.

Wealthfront managers have returned an average of 30 percent from the site’s start in October 2009 through Feb. 18, compared with a 27 percent gain in the Standard & Poor’s 500 Index. The managers charge average fees of 1.3 percent.

Richard Ferri, founder of Troy, Michigan-based Portfolio Solutions, builds index fund and exchange-traded fund portfolios for clients and rebalances them periodically for a fee of 25 basis points. A basis point is 0.01 percentage point. Rebalancing during times of market turmoil may add about one percentage point to returns annually, he said. The firm has almost $1 billion in assets under management.

Saving Money

Investors could save more money on their investments and improve their returns by skipping services such as MarketRiders and making decisions themselves, said Burton Malkiel, professor of economics at Princeton University and author of “A Random Walk Down Wall Street.” The 10th edition of the book was published in January.

He recommends investors hold a mix of the Vanguard Total World Stock Index exchange-traded fund and a broad-market bond exchange-traded fund such as the iShares Barclays Aggregate Bond Fund (AGG) or the Vanguard Total Bond Market exchange-traded fund, and rebalance annually.

“I don’t want to pay 25 basis points to anybody to do that for me,” said Malkiel.

To contact the reporter on this story: Elizabeth Ody in New York eody@bloomberg.net

To contact the editor responsible for this story: Rick Levinson at rlevinson2@bloomberg.net.

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