In a recent Motley Fool post, “Will This Start-up Kill the ETF Revolution?” the author states: “a new start-up company is looking to bypass the management fees that ETFs charge, instead giving you direct access to baskets of stocks for a single inexpensive commission — and letting you tailor the portfolio to your own particular needs.”
The investment firm that the writer is referring to is Motif Investing, which enables an investor to pick a theme (or “motif”) and their system will generate a portfolio based on the selected theme. The investor can then modify the chosen portfolio or take it as presented. Once the investor decides on the final construction of the portfolio, Motif will purchase up to 30 stocks or ETFs for a total commission of $9.95. Examples of the Motif portfolios include 3D printing, big data, Chinese solar, shale oil, battling cancer and rising interest rates. In other words, just about any investment theme that can be executed upon via the capital markets.
There is an interesting comparison in Folio Investing. The firm, which was introduced 15 or so years ago, was first thought of as a major threat to the mutual fund industry due to its low-cost “Ready-To-Go” portfolios. Even though it has remained in business and made progress, the prediction that investors would flock to Folio to save on fund expenses never really materialized. These days Folio has a softer message than before — to “combine the advantages of mutual funds with owning individual stocks.”
These do-it-yourself portfolios based on a template present several challenges:
• The expense ratio of a mutual fund or an ETF is only part of the expense story. There are also the underlying costs of executing the transactions, and it is not just about getting the cheapest brokerage costs. Traders — who are focused on being liquidity providers and managing the bid/ask costs — can add significant value as it relates to keeping the underlying transaction costs under control. A trader’s job is made even easier if they do not have to concern themselves with tracking error, which is always the case when tracking a commercial index (e.g., the S&P 500).
• Most ETFs are used as building blocks of well-diversified portfolios. Even sector-focused ETFs are primarily used in combination with other ETFs to round out a portfolio’s objectives.
• The theme approach to investing can be a bit like looking in the rearview mirror in that excitement about a new technology (e.g., 3D printing) can quickly become overbought, as was dramatically illustrated in the dotcom era. Microsoft, a great company, never has and probably never will make it back to its dotcom era valuation.
• With these do-it-yourself portfolio providers, there seems to be a lot of hype around the most recent and hottest themes. This is borne out by looking at both the Motif and Folio websites, on which the hottest themes with eye-popping returns are placed front and center. Given investors’ tendency to be backward-looking and pattern seeking, it is easy to fall into the trap of chasing the latest investment theme. This is more of a close cousin to gambling than prudent investing.
• Brand still matters, especially when dealing in the world of cyberspace where anyone who can rub two nickels together can create a website. There is a reason that certain ETF providers are doing better than others, and it has to do mostly with brand.
• While both Folio and Motif reach out to advisors, most advisors prefer a more conventional approach to investing in which a money management firm is ultimately responsible for the construction of the pooled investment vehicles and, in most cases, the asset allocation overlay as well.
Conclusion
There is no doubt that technology will continue to move forward and that it has the potential to radically change business models. (Think of Schwab and the discount brokerage model.) Change will not slow down; if anything, it will accelerate. At least for now, these build-it-yourself portfolios using pre-fab templates as a starting point will most likely appeal to niche investors (as opposed to the masses who want the comfort of brand and investors who are not overly concerned with getting what is perceived as rock-bottom pricing). Many, if not most, investors are looking for a complete financial plan as opposed to making a big investment gain before everyone else catches on to the latest hot investment theme.
In the DC space, where new investment vehicles and asset classes are introduced at a glacial pace (e.g., ETFs), other than in self-directed brokerage accounts, don’t expect to see these virtual fund structures making their way into plans for many years to come.
