Given passive investing’s enormous popularity, wealth advisors that pick stocks for clients are ever scarcer.
A study by Cerulli Associates, a Boston-based financial research firm, revealed that in 2010, 90% of independent RIAs chose individual equities for client portfolios. By 2019, only 69% did. Experts anticipate that trend will continue.
Among advisors that own individual stocks, many use them to supplement large holdings of diversified, index-type funds. Gene McGovern, a certified financial planner based in Westfield, New Jersey, said for clients seeking stock exposure, he recommends a core-and-satellite approach, with 90% invested in index funds, ETFs or similar vehicles, and up to 10% in stocks.
Ken Van Leeuwen, managing director and founder of Van Leeuwen & Company, a Princeton, N.J. based boutique financial management firm, says “individual stocks can help cut costs and potentially increase returns in the long-term.”
Van Leeuwen, whose firm manages $260 million in assets and requires a minimum $500,000 investment, says “owning individual stocks allows us to manage the risk in a portfolio more effectively than using funds or preset models.”
Some clients prefer stocks because they are “more tangible. They feel more engaged in the investment. Owing a share of a specific company resonates more than owning a fund that has many holdings,” Van Leeuwen points out.
The stock-picking suits Van Leeuwen’s clientele. Many are corporate executives who built their wealth through stock options and restricted options and fully understand the associated risk.
In fact, he meets with individual clients, who, for example, might be sophisticated pharmaceutical executives who can share their “intel on the competitive market, without giving insider information. They have the bird’s-eye view and know the senior executive and marketing intelligence.” So if Bristol Myers Squibb acquires businesses from Celgene, they know the ramifications.
Van Leeuwen adds that index funds are often “the easy way to go. In the fourth quarter of 2018, I saw the lack of benefit of how indexing didn’t pan out. Just because it’s easier doesn’t make it better.”
Investing resources into stock selection and hiring two CFAs to pursue research is worth the money, he said.
Some of his clients also set aside small amounts to invest on their own. Van Leeuwen calls those “sandbox” accounts, which he doesn’t oversee.
Van Leeuwen has bought stocks exposed to the cloud, including Amazon and Microsoft, as well as Equinix and Digital Realty, which own data center buildings. He’s avoiding big-box retailers. “I’m not sure how Macy’s will reopen 40 stores soon.”
Liz Miller, president and founder of Summit, N.J.-based Summit Place Financial Advisors, which has $150 million in assets under management, said her firm offers individual stock portfolios and ETF portfolios.
Miller notes that 30 years ago, most independent mid-sized and larger firms vigorously trained junior analysts to build portfolios and recommend investments, based on fundamental research. Today, many RIAs are led by former wirehouse employees who know how to recommend ETFs and index funds.
Miller considers stock portfolios “the least expensive option since most trading costs have come down to zero. With a structured stock portfolio, I have more confidence than I can manage my client’s roller-coaster.”
Summit Place Financial attracts clients with $5 million in assets, usually derived from multi-generational families, most of whom are referred. Clients are fully aware that Miller and her staff of three advisors pick stocks, which is one reason they like the firm. It’s a differentiator, she says.
Given the pandemic, Miller sees potential for stocks that “help clients performing remote activity, approaching things more digitally, focus on health and well-being are positioned well for the future.”
Conversely, financial stocks will likely struggle amid a reeling economy. Industrial stocks, defense names, and those that depend on government spending are vulnerable, she suggested.
Miller adds that “an individual security portfolio can be built to manage an individual’s appetite for volatility, more specifically than a fund portfolio.”
Not all advisors are sold on the human touch. Daniel Philips, a London based investment manager at Rothko Investment Strategies, relies almost exclusively on Artificial Intelligence-based (AI) selections. He argues that “humans are flawed decision makers, and people make decisions at a very stressful point, and often suffer from cognitive bottlenecks.”
Conversely, AI for stock selection “emulates expert human decisions, making it entirely objective.” Philips acknowledges that some stock pickers have “overcome many of their behavioral biases, and some are good at it,” but he insists that “the only level of consistency in stock selection are those that are consistently bad.”
Philips says that Artificial Intelligence has become a catch-all term that encompasses everything from chatbots to robo-advisors but asserts that it’s the safest, most efficient, and most effective way to achieve long-term growth.
Venture capital firms and others believe AI could provide a solution, too. Vise, a portfolio management software company that uses AI, recently raised a $14.5 million round of funding led by Sequoia Capital.
However, Philips acknowledges the impact of the market’s recent volatility. “We’re a value approach. Value investing hasn’t done well in a crisis; it tends to underperform at the sell-off and outperform at the recovery.”
Critics of stock picking point to added complexity. Index funds allow for “broad diversification at a low cost,” explained Dave O’Brien, who is chairman of The National Association of Personal Financial Advisors. Replacing them with individually-chosen stocks requires “more moving parts and you’re adding more trading costs.”
Choosing stocks and keeping track of them to balance and update portfolios can be extremely time consuming. “If you’re doing stock research and portfolio management, you don’t have the time to do anything else,” O’Brien said. Some larger firms have the resources to create their own research teams, but they’re in the decided minority.
The way the industry has moved, most clients aren’t looking for stock-pickers any more, O’Brien noted.
The market has become so unpredictable and volatile that no RIA can predict the future, making stock selection exceedingly difficult, O’Brien said. He pointed to General Electric (GE), a perennial growth stock turned fallen angel.
“You never know when it will happen. That’s the thing about stock picking and active portfolio management; we’re not good at predicting the future.”