Schechter: Long term allocator with direct indexing at core


Schechter Investment Advisors, a third-generation wealth advisory and financial services firm, was founded in the 1970s by Robert Schechter, who was formerly one of New York Life's top insurance salesmen before founding the firm.

The Birmingham, Mich.-based firm. is one of the fastest growing RIAs, landing at WealthManagement.comS ' RIA Edge 100 list for 2024.

Aaron Hodari, chief investment officer and managing director, provides a cap within the RIA's $3.45 billion moderately aggressive model portfolio.

The following has been edited for length and clarity.

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WealthManagement.com: What's in your model portfolio?

Aaron Hodari: I'll start by saying that our models are not fixed in terms of asset allocation, so our typical portfolio is more risk-oriented. Asset allocations within the models can vary depending on where we see the markets and where we see the opportunities. A typical model of a moderately aggressive portfolio might be 60% stocks, 20% fixed income and 20% alternatives.

A public equity portfolio will be index based, and depending on the size of a client's portfolio, we will either use direct indexing or ETFs. Now, if it's a larger client that meets the minimums needed for live indexing, we will do that. Alternatively, we will build a very similar exposure through ETFs.

We're not typically making big trade-offs between growth and value, small-cap, international. We would like to have a very long-term focused allocation that includes large caps, small caps, domestic and international value and growth, with a broad representation of global equity markets.

We will include private equity in that equity bucket. So instead of being 60% public equity, it could be 45% public equity and 15% private equity, but private equity is not suitable for every client. But we believe it is a diversifier and can potentially increase returns.

On the fixed income side, we typically use mutual funds and ETFs, and are quite active in managing interest rate and credit risk. There will be times when we have very short durations and then, over time, we can increase durations within fixed income portfolios.

WM: Which way are you leaning right now in terms of duration?

AH: The last four or five years have been extremely short. Over the past year, we've started to slightly increase the duration to lock in these higher yields for longer. However, we have by no means gone long or even intermediate. Our fixed income mix will still be in the short-duration direction.

The reason we are starting to expand is that today there are opportunities to lock in these higher yields for longer. In some asset classes, like municipals, especially high-yielding municipalities, you're seeing higher yields as you go further up the curve. This is not necessarily true in other markets, so it depends on the client, but we are starting to see opportunities to lock in higher yields that are attractive enough for longer.

WM: What does the distribution of alternatives look like?

AH: The growth of mutual funds and product innovation in the alternative space has allowed the use of alternatives to be used far more in client portfolios than could have been the case 10 years ago. We can even use range funds within UMAs. Our customers usually have around 20%, and we are today mainly focused on private credit. There have been times in the past where we've included real estate, but we've been a much bigger user of private credit for the last four or five years within our core portfolio.

WM: What opportunities do you see in alternatives and private loans specifically?

AH: If a client can handle the illiquidity that comes with the asset class, historically, that's a good trade-off, and we're seeing yields on middle market direct lending north of 10% today. Much of the private loan is variable rate, which has been very useful over the last four years. As you have seen rates rise, it has been a difficult environment for fixed income and the private loan market has benefited from its variable rate nature as well as relatively low default rates to date.

Now, this is a risk because these are typically sub-investment grade loans, and so you, as an advisor and as a client, need to be aware of the credit risk you're taking on within the private credit markets. You have to monitor what's going on within the default rate and loss rate environment, but it hasn't been terribly alarming to date.

WM: What is your investment philosophy and how does it stand out in the market?

AH: We are long-term investors. We believe that if you build a good portfolio, pay attention to taxes, pay attention to fees, and stick with it, you should do well over time. And market timing, while it may work for some, if it goes wrong, it can stop helping clients achieve their long-term goals.

A customer will say, “Well if that happens, how will the wallet work and how do we change it ahead of time?” And I say, “The best defense you can play as an advisor and investor is to have a well-diversified portfolio that can weather any economic environment that comes along.” So the first thing is the long-term nature.

Second, we are very tax conscious. Within our models, we have automatic tax loss harvesting, either using direct indexing or ETFs. We are very sensitive to a customer specific tax rate. I have seen low income tax bracket clients who own munis. You should look at your client's tax brackets and, on an individual basis, build portfolios that can reflect how to best take advantage of their tax situation.

We are very conscious and aware of fees. This does not mean that we will always choose the product with the lowest fee for our customers. Our goal is to get the best rate network, without tax refund.

Another differentiator is our use of alternatives. While I believe the industry will continue to increase the use of alternatives, I think we have been an early adopter and heavy user for the past eight years. It's put us in a position where we know a lot of the managers there, we've built relationships and we're able to talk to them while the products are still in the lab.

WM: Have you made any significant changes in your investment allocation in the last six months to a year? If so, what changes?

AH: The main change is that we continue to reduce exposure to real estate. We started that process about two and a half years ago and have continued to do so.

You've had rent increases in 2021 that were astronomical and there's been a continued slowdown in rental rate growth. Whether it goes fully negative or not, national rent growth has slowed.

You saw equity rates remain very low at a time when interest rates were rising, and that's not sustainable. One of two things has to happen, in my opinion. Capital rates must rise, or interest rates must fall. I don't want to bet on a big move in interest rates in our clients' portfolios.

And I think there are continued pockets of stress, not just in the office market, but across all real estate sectors, where you've had new construction financed with short-term debt. As these loans are coming due now, this higher interest rate environment is causing many problems for recently purchased or constructed properties.

WM.com: What else can you say about your use of live indexing?

AH: North of 90% of clients whose portfolios are large enough to access direct indexing use direct indexing.

We work and talk to many live indexing providers. We do this to gain flexibility and ensure we can negotiate the best rates on behalf of our customers.

We use direct indexing because we want the broad market exposure and tax efficiency it provides. It allows us to hold legacy securities that customers may have. This allows us to maximize tax loss harvesting. So we're not using direct indexing to correct the index and say, “I want to have a big value or a bullish bias.” We want the whole index, and we want the customization ability for legacy holdings, as well as the tax loss harvesting capabilities that come with it.

WM.com: Do you include ESG?

AH: ESG comes up very rarely for our clients. However, direct indexing gives you the flexibility to help clients create a portfolio that meets their needs. We have a few clients who have requested ESG screening on top of their direct indexed portfolios, but not much comes up.

WM.com: Do you have any interest in bitcoin ETFs? Crypto?

AH: I am not comfortable on a proactive basis at this point recommending these types of positions. However, we have clients who want exposure and we can help them gain that exposure, especially now with the recent launch of these ETFs. And if we're going to see an ETF, we'll want a big one with big trading volumes brought in by a manager who has extensive experience running ETFs.

WM.com: How are you handling the inflationary environment within the portfolio? How are you handling “higher for longer” interest rates?

AH: Being underweight for a long time is not as dangerous, in my opinion, as being overweight for a long time. But this is a very complicated environment because you're looking at the media and the stock market cheering the bad jobs report because it's signaling that the Fed might be able to taper faster. Advisers need to be very careful, because if you're cheering on bad jobs reports that signal the economy may be slowing down, there are many other risks that come with that.



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