In 2007, CEO Rick Kent founded Merit Financial Advisors as an Atlanta registered hybrid investment advisor. He has since grown it into a $10 billion enterprise with more than 40 offices in the US, backed by Wealth Partners Capital Group and a group of strategic investors led by HGGC. And this month, Merit launched a new 1099 link model.
Merita has added great talent along the way, including Brian Andrew, who recently joined as the firm's chief investment officer from Johnson Financial Group. Andrew has been responsible for managing the firm's investment department and asset allocation decisions. He will also play a key role in integrating new partner firms that Merit acquires.
WealthManagement.com I recently caught up with Andrew, who offers a look inside one of Merit's flagship model portfolios.
The following has been edited for length and clarity.
WealthManagement.com: What's in your model portfolio?
Brian Andrews: There is a mix of passive and active in the portfolio – the passive is mostly ETF positions. We are very cost conscious in terms of building portfolios for clients. And so, ETF exposure helps with costs.
Second, we are tactical in nature, meaning we are interested in making changes on a short-term basis. Being able to make changes to ETF positions is easier. Naturally, they are more sensitive to changes in the market, so it allows us to be more flexible in our tactical positioning. So this is the main reason to have passive and active exposure.
I will say, just given the size of Merit, we have all ETF model portfolios. This basic portfolio that we are discussing here is the one that is most widely used across the organization. But for clients and advisors who are super cost-conscious and really want to index, we have ETF portfolios that follow the same strategic and tactical positioning that the core portfolio follows.
This core pattern is about 60/40. We hold an average cash position of about 2%, and we're not really making what I would call big strategic asset allocation bets where we're 50% equity, and then we're 75, and then we're 25. We can overweight the equity or underweight it by 2 or 3 percentage points, but not significantly.
The tactical changes really happen within the asset class. If you think about large cap, versus smaller growth, versus value, or high credit quality, low credit quality, that kind of thing. On the bond side of the portfolio, we worry about interest rate sensitivity; we worry about sector allocation. We worry about credit quality.
We think a little about the shape of the yield curve. Today, the curve is still inverted from short to long, and so we believe there is an opportunity in the middle part of the curve, and we would take advantage of that, while maybe at other times, we would be more bullish. short and long. So that's a positioning change that we would make on the bond side of the portfolio. This is actually another good example of where ETFs would be easier to do this with an active core bond manager.
WM: Within the capital allocation, what is the weighting of domestic versus international?
BA: Our benchmark is the MSCI ACWI index. We have a higher international and emerging markets allocation in our benchmark than if we used a mixed domestic-international benchmark. So, compared to ACWI, we are underweight international emerging markets by about 10%. We have a little less than a third of the share of capital allocated to internationals.
People have been saying that international stocks are attractive on a valuation basis for a long time, but that continues to be the case. There are still some significant opportunities out there. But when you look at the portfolio, there's more active exposure because we think those active managers are better positioned.
Ratings are where they are for a reason. The European economy does not appear to have the same recovery as the US. There is weakness in China, which brings weakness throughout Asia. Many European companies and manufacturers, in particular, are export-oriented. That's why the ratings are where they are. But I think that's where having that extra exposure, if you will, presents an opportunity at this point in time.
We are also slightly overweight small and mid-cap stocks, and this is similarly due to valuations. The small cap, in particular, has been very unfavorable. And we all know if you look at the S&P 500 and take the top 7-10 names, you take out more than 75% of the performance.
If you look at the valuations of the Russell 2000 as an example, it's trading at a relatively low level compared to the rising Russell 1000. I'd say we're probably in the small cap managers that don't need a big cyclical recovery for earned. I don't think our view is that the economy will go from 2% growth to 5% in 2024. I think we'll be lucky to get 2% for the year. But still, from a valuation perspective, we think there's more opportunity in that part of the market.
WM: Have you made any major allocation changes in the last six months or so?
BA: Overweight to small- and mid-cap stocks is a change that happened late last year.
The other change is more on the fixed income side of the portfolio, where we had short duration. Our benchmark is the Bloomberg Aggregate Bond Index, which has a duration of about six years. We have been well under four and are currently just over four years old. So this increase in duration came from supported yields between the third and fourth quarters. But we still fall short.
We also changed the structure of active managers to improve credit quality. Our view is that we haven't seen all the downsides that we're going to see. And the difference in yields between Treasuries and corporates, for example, is still very narrow on a historical basis. We think it makes sense to have a higher quality loan portfolio compared to the benchmark. The high-yield bet that was there is mostly gone, and we've grown in average credit quality across the portfolio.
WM: You mentioned that you keep 2% in cash. Why do you keep money?
BA: I wish I could tell you there was a science to it, but two things: One is, if I could run it to zero, I would, but we know there are always distributions or expenses like investment management fees that come out from the wallet. To make sure customers can be fully invested and don't end up with overdraft related costs, we hold some cash. Second, Merit has done a great job of improving the way we use trading technology, so that number has gone down. Hopefully we can get back to a 1% number there. That number was probably closer to 5% before we made improvements to how we market and the technology we use.
WM: Is there a particular structure in which you put that money?
BA: For clients who we know can do something with their money, we can trade it out of a money market fund and into an ultra-short duration fund, given the fact that their duration will be closer to a year compared to 30 days in the money market fund. You get a pretty good yield return on cash to the extent that you can own it, and people can get the marginal volatility that comes with an ultra-short duration fund. That would almost be on a customer-by-customer basis, not necessarily in a model, but we have that flexibility built into the way we're doing things.
WM: Do you share about private equity investments and alternatives? If so, which segments do you like?
BA: The organization has been using liquid alternatives for some time and has several model portfolios using liquid alternatives available to advisors as a sleeve for clients who are interested in that alternative allocation. And that really came as a result of the low-yield environment that existed for so long. It was a way for clients to have an income component using alternatives as opposed to using traditional fixed income.
Within this sleeve, there is exposure to private equity, private credit and real assets, such as infrastructure or commodities, through liquid alternative funds. People can own it and fund it from income or from the equity portion of their portfolio, depending on their return objective.
On the private placement side, we are in the process of evaluating external partners. We will likely start with a partnership with a larger national firm, such as a CAIS or iCapital, that can provide us with access to private placements. This would eventually lead to us creating our own white label fund, where we choose what investments will end up in that fund and then make it available to clients who are able to invest in alternatives because of their accredited or qualified status.
We do not need a partner to give us access to funds. It's really more about how they can help us from a technology perspective with subscription documents, research and due diligence, and then help us think about how to bring those funds together in strategy for clients.
WM: What sets your portfolio apart?
BA: I mentioned earlier the idea of using passives and actives in the same model portfolios and having all passives available as well.
Another thing is that it is just as important to understand the performance cycle of an active manager as it is to understand how they manage money. What I mean by that is that people talk a lot about tactical differences between factors like size or growth versus value or dividend yield, for example. If you look at a particular segment like small-cap growth, not every small-cap growth manager is the same and they have different cycles of performance through a market cycle. Some are more or less competitive depending on the underlying economic themes. And one small-cap manager's catalyst is not another's.
One of the things that sets us apart is going beyond understanding the long-term performance history to understanding the team, their approach to stock picking and how it works at different points in a market cycle and based on what the underlying economic environment looks like. . Because then you can not only be a tactician, moving in and out of small or large, but also one manager against another based on how they perform compared to their peers. This allows you to take advantage when a manager has overreached; you may be more comfortable selling your winners and buying your losers because you understand that over time the strategy will work.