Behind the Scenes of Your Portfolio: ETF & Mutual Fund Research & Monitoring

For many investors, once they have made a decision to purchase an ETF or mutual fund, they tend to breathe a sigh of relief and move on. Although there needs to be significant upfront due diligence in selecting investments, we do not recommend blindly trusting that the managers remain consistent, nor that the specific investments continue to fit into your portfolio. One important ongoing aspect of investment management is to ensure the investment vehicles recommended remain as high conviction as when we first recommended them. This applies even if we still want to maintain exposure to the same asset class. Let’s walk through a few examples of how we continually monitor the ETFs and Mutual funds that make up our recommended portfolios.

Ongoing, Proactive Review

Each investment that our clients own receives a ranking: Recommended, Actively Monitored, Followed, Terminated or No Status. On the Recommended and Actively Monitored side, we complete a full review of the strategy and management team on at least a semi-annual basis regardless of any specific reason to. Followed rankings tend to include strategies that we have previously recommended but are not adding more to the strategy going forward. However, many of these have tax implications to maintain the positions, so we complete a review at least annually. Typically, the Terminated and No Status are either old recommendations that we want to avoid or “legacy” positions from clients that are not recommended. We have completed initial due diligence, but we typically will not be proactively meeting with the mutual fund management teams.

To complete all of these ongoing reviews, it helps to have a deep team that can meet with management teams. For instance, our research partners at Fiducient Advisors recently met with the management team at Dimensional Fund Advisors (DFA) to learn about the most recent research that DFA has applied to the security selection and trading within their ETFs and Mutual funds. After this meeting, together we reviewed the implications on client portfolios and agreed to make no changes to our allocations to DFA funds or ETFs.

Underperformance

At times, investments can underperform our expectations and their benchmarks. When we see periods of underperformance, it is important to understand the causes. These will likely range from poor decisions by the manager, shifting strategy or just bad luck. We do not want to be quick to exit an investment just because of short-term underperformance, but we also want to ensure the reasons we invested remain.

Recently, DWS Real Assets fund has underperformed it’s benchmark for a several quarters, although they continue to outperform on longer time periods such as 5- and 7-years. We reviewed the underlying components that have led to recent time periods of less favorable returns. Based upon the economic models used by the fund manager, we were able to identify a few specific allocation decisions that did not pay off. One of the biggest factors for the recent underperformance was the exogenous shocks in the market from Geopolitical uncertainty around the Russian invasion of Ukraine and the ongoing conflict in the Middle East. The DWS portfolio was positioned for a macroeconomic environment that did not plan for these conflicts (not that any model could have predicted the exact events). Additionally, we were able to identify that the managers at DWS Real Assets Fund positioned their portfolio based upon their quantitative model suggesting faster Fed rate cuts than has actually happened.

Even with both drivers of underperformance, we believe this is in line with the expectations originally identified when pursuing this strategy. We are comfortable with the main quantitative models used by the mutual fund team going forward, and we are not looking to make any changes to this within client portfolios.

As components of the portfolio underperform, we focus on understanding the drivers of underperformance and establishing a plan to keep or remove the specific investments from our clients’ portfolios.  

Event Driven Due Diligence

The last example is around events that would cause us to take a deep dive into the ongoing management of the investment that have nothing to do with regular due diligence or periods of underperformance. The reasons can be vast, but there are times we need to complete “emergency” measures. This would include a sudden change in the fund manager, regular turnover within the mutual fund company or even negative news articles.

Our most recent Event-driven due diligence review was in response to a scathing article in ProPublica about a company that we recommend, Dodge & Cox. According to the article, the mutual fund manager of a fund WE DO NOT OWN at Dodge & Cox supposedly was implementing trades within their personal portfolio just before recommending that their own mutual fund made similar trades. This allegation suggests layers of failure at Dodge & Cox within their personal trading compliance, oversight and ethics policy. This article spurred immediate action by our research team at Fiducient Advisors. Over multiple meetings, our team was able to glean vital insight to the internal dynamics at Dodge & Cox and the specific actions taken behind the scenes. We learned that Dodge & Cox hired an independent compliance firm to complete the investigation and review of internal procedures, and that none of the implications in the article were founded. Over multiple meetings with Dodge & Cox, our team has remained comfortable with the internal controls and we continue to recommend holding some of their funds within client portfolios.

If the internal team members at Illuminate Wealth Management had attempted to speak directly with the management at Dodge & Cox, we would not have been large enough to get a meeting. However, one benefit of working with Fiducient Advisors is their size and scale, which allows for better access when needed.

______________________________________________________________________

While we rarely discuss the portfolio components at this level of detail, it is important to understand the overall ongoing due diligence process that is happening behind the scenes of your portfolio. We will continue to monitor all the positions within your investment accounts and will proactively reach out if any changes are necessary. If you would like to discuss this or anything else in our portfolio management process, please let us know!