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Investing Specialists

Phil Huber: Finding an Edge in Alternative Investments

The blogger and CIO of Savant Wealth Management discusses his new book on alternative investments amid a sobering outlook for the traditional 60% stock/40% bond portfolio.

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Our guest this week is Phil Huber. He is chief investment officer at Savant Wealth Management, a fee-only registered investment advisor. Previously, Huber worked for Huber Financial Advisors, which Savant acquired in 2020. Huber is active in the financial blogosphere with his blog bps and pieces.com. He has a bachelor's degree in finance from the Kelley School of Business at Indiana University and has earned both the Certified Financial Planner and Chartered Financial Analyst designations. Huber is also the author of a new book, The Allocator's Edge: A Modern Guide to Alternative Investments and the Future of Diversification.

Background

Bio

Savant Wealth Management

Bps and pieces

The Allocator's Edge: A Modern Guide to Alternative Investments and the Future of Diversification

Trade Allocations and the Case for Alternatives

"Evidence-Based Investing: Application and Monitoring," by Phil Huber, savantwealth.com, March 22, 2021.

"In Defense of Complexity," by Phil Huber, bpsandpieces.com, March 16, 2019.

"The Four C's of Investment Costs," by Phil Huber, bpsandpieces.com, Nov. 3, 2021.

"Inflation: Temporary or Here to Stay?" by Daniel G. Noonan, savantwealth.com, Sept. 15, 2021.

"Ask Meaningful Questions: Bonds and Alternatives," by Phil Huber, savantwealth.com, March 21, 2021.

The Elements of Diversification," by Phil Huber, bpsandpieces.com, Nov. 19, 2018.

Retirees

"Three Tips for Evidence-Based Retirement Plans," by Isaac Presley, cordantwealth.com, Nov. 29, 2017.

Practice and Behavioral

"Diversification Means Always Having to Say You're Sorry," by Brian Portnoy, forbes.com, March 9, 2015.

Liquid Alts

"Liquid Alts Revival?" by Phil Huber, bpsandpieces.com, April 7, 2021.

"Inside the Morningstar Style Box for Alternatives," by Jason Kephart, Morningstar.com, Oct. 30, 2017.

Indexing and ETFs

"Patrick O'Shaughnessy: 'Custom Indexing Unlocks a Lot of Benefits'," The Long View, Morningstar.com, May 12, 2021.

Canvas

"For a While, Bond Funds Were an Exception to the Indexing Rule," by Carla Fried, nytimes.com, Jan. 11, 2019.

"Around the ETF World in 80 Hours," by Phil Huber, bpsandpieces.com, Feb. 14, 2020.

Transcript

Jeff Ptak: Hi, and welcome to The Long View. I'm Jeff Ptak, chief ratings officer for Morningstar Research Services.

Christine Benz: And I'm Christine Benz, director of personal finance and retirement planning for Morningstar.

Ptak: Our guest this week is Phil Huber. Phil is chief investment officer at Savant Wealth Management, a fee-only registered investment advisor. Previously, Phil worked for Huber Financial Advisors, which Savant acquired in 2020. Phil is active in the financial blogosphere at his blog "bps and pieces.com." Phil earned his bachelor's degree in finance from the Kelley School of Business at Indiana University and has earned both the CFP and CFA designations. He is also the author of a new book, The Allocator's Edge: A Modern Guide to Alternative Investments and the Future of Diversification.

Phil, welcome to The Long View.

Phil Huber: Thank you so much for having me, Christine and Jeff. It's a pleasure to be here. I'm a regular listener to your show, and I'm honored to be on as a guest. So, thanks for inviting me.

Ptak: Well, we appreciate that. And it's our honor to have you on as our guest. We're really looking forward to the conversation. Some of our listeners will be familiar with you but not all of them. So, let's start off with your CV--talk about your role and responsibilities at Savant and where your recently published book fits into all that.

Huber: I'll backpedal a little bit and just give you a little sense of my start in the industry and my career. I grew up in and around the RIA and wealth management industry. My father is a financial advisor, and he founded a firm called Huber Financial Advisors back in 1988. So, I joined there in 2008. I had a sense at an early age that I wanted to participate and join the family business. And so, 2008 was my entrance into the industry. And it was a pretty crazy year to see the side of the business. But I think a lot of great lessons learned throughout that painful period as well.

I kind of started as a utility player, took on a lot of different roles. We were a much smaller organization, so everybody wore a lot of hats. But it became increasingly clear to me as time went on that my passion and focus area was going to be on the investment side. Ultimately, as I developed within the firm, I eventually became chief investment officer of Huber Financial. That was about five or six years ago. We have since merged with Savant Wealth Management based in Rockford, Illinois. And that's been in the works since February 2020, so a little over a year and a half now we've been a part of Savant, and that's been a great experience so far as well. I've taken on that same role and same capacity within Savant. Similar types of activities, but just with a larger kind of footprint in terms of the number of advisors and clients that we have to support in different office locations. And it's a great honor to have this kind of role. It's such a large enterprise-type RIA.

And a big part of my role, and I think any CIO within the RIA space, is really focused on communication. Yes, there's a lot of behind-the-scenes research and due diligence, but that's a team effort with my research team. We have a handful of analysts and our director of research. But my role as CIO, I think, is very much more focused on how do we best communicate our investment philosophy and our process to clients and other constituents.

And that comes in a lot of different forms. I think you both know that I'm fairly active on social media. I've also got my own investing blog called "bps and pieces." But the latest iteration of my attempts to find different mediums to communicate our investment approach, and specifically a component or investment approach, has been the recent writing of a book that's coming out in a few weeks here.

My new book called The Allocator's Edge is really focused on alternative investments, because as I had firsthand experience over the years working with our advisors and with our clients, this was an area that, despite our having a fairly strategic and consistent allocation to different types of alternative investments within our portfolios, it was clearly an area where there was an education gap, both at the advisor level and the client level that I thought writing a book could be a good way to help try to fill this gap and develop what I hope to be sort of a reference guide book for advisors and other professionals on how to best interpret the kind of why, what, and how of investing in alternatives.

Benz: We want to delve into the book, and you start it by examining the traditional 60/40 portfolio. It's performed really well but you question whether that's going to last. You cite high valuations and low bond yields. The 60/40 seems to live to dispel doubts about it. So, why do you think it's been so hard to beat?

Huber: The first chapter of the book is focused on picking apart in some ways the traditional canonical 60/40-type stock-bond portfolio. And I do so not to make any grand proclamation that you should have no bonds or no stocks. It's really meant to say: This simple blended portfolio that served investors well for many decades now, is less equipped to do so going forward than it has been in the past. So, there's been many proclamations of the death of 60/40 over the years. This has been a conversation happening in our industry for what seems like a decade now. And one of the challenges with that is that it's continued to defy the odds.

People have pointed to high stock market valuations and low interest rates. It's that dual reason why 60/40 is poised to deliver lower future returns than it has in the past. And I think that still rings true that that's just simply the math of how things are. Particularly, on the bond side, it's much more clear-cut. But even on the stock side, we know from history that starting high valuations tend to be a precursor to lower-than-expected future returns. That being said, valuation, as we know, is not a great timing tool. You can't necessarily look at those starting valuation metrics and say, “The 60/40 is going to do terribly over the next 12 to 18 months.” It's really more of a long-term forecast that we assume that 60/40 is going to generate lower returns because that's just what those metrics are telling us. I thought that was a natural starting point of the book, because that tends to be where most advisors and clients anchor to, and maybe that's their starting point. So, if the book is about alternatives, and what role they may or may not play in a portfolio, I think best to start with, what are most people doing today to try to build a diversified portfolio, and what are some of the potential pitfalls of that approach going forward before diving into what we can potentially do to remedy that?

Ptak: That makes sense and is practical. Maybe we can talk about some of the specifics of the forecasts that you make on behalf of clients that you work with. If you look at a 60/40 portfolio and you try to project out, say, a couple of decades, what kind of nominal return do you think we're talking about? Obviously, we've been accustomed to really nice returns from the 60/40 in the past couple of decades. But what do you think the next few decades might look like?

Huber: I guess I'll preface that with this notion of we do publish forward-looking expected returns at Savant, both at the individual asset class level as well as the kind of portfolio level, and we look out 20 years. I'll preface it by saying our forecasts are no more precise than any other fund company or asset manager or banks' long-term expected asset class returns, and that the idea is to be vaguely right and not precisely wrong. We know that once we get to that 20-year period from now that our returns will not be exactly what we're publishing. But I think it's an important exercise to try to help figure out how do we best construct diversified portfolios today based on the raw materials that we have at our disposal and where the best risk-reward opportunities are.

But also, those long-term numbers go into our financial-planning software--they're the assumptions being used to ultimately generate clients' financial plans. And so, they are important despite how imprecise that they might be, and we know that. So, we're modifying them and updating them on a regularly frequent basis. But we know there's obviously flaws in any of that kind of long-term expectation. But back to your original question, if we're looking at our expectation for a simple 60/40 stock-bond portfolio, today our firm at least has that as about a nominal 5% return, that's before inflation over the next 20 years. So, still in positive territory, but relative to the historical returns that that type of portfolio has delivered, it's materially lower going forward, in our opinion.

Benz: You reference the lower return expectations for fixed income, that being the result of very low yields today. How about the cushioning effect that bonds have delivered for equity portfolios historically? You question whether that will hold up going forward. Can you walk us through your thinking there?

Huber: I think very few correlations between asset classes are written in stone. The experience we've had as investors over the last 20 to 30 years has been one of a modest negative correlation between stocks and bonds. Bonds have been counted on and have delivered to their credit, generally speaking, positive returns when equities have gone down in any kind of significant fashion. And so, they've behaved as a good diversifier. That being said, we know that correlation properties can change over time. And we can look over longer data sets, stretching back even beyond the last few decades, and we can see that actually more often than not stocks and bonds have had a slightly positive correlation. So, they've still been diversifying to one another. But this notion that bonds are always going to generate significant positive returns when equity markets correct, I think is one that's more specific to the regime we've been in for the last 30 years and not necessarily a written-in-stone relationship.

And so, we know that from the ones--it's a sample size of one effectively for the U.S. But when we have had one extended period of high and rising, persistent inflation, that's the Kryptonite that can cause bonds and stocks to go down in concert with one another. And inflation is all over the news and headlines today. It's a big topic of interest and concern for many investors and allocators. And it's anyone's guess as to whether it ends up being transitory or ends up being very structural and persistent. But that being said, without having to make any kind of major prediction about inflation, like any diversification strategy, you want to have a portfolio that's prepared for a variety of different economic outcomes that are possible. We know inflation can be that one variable that can ultimately disrupt that relationship between stocks and bonds.

And I think the other piece is, yields are just significantly lower today than they have been in the past. And so, there's less coupon, and there's less room for prices to appreciate during recessionary-type periods when historically central banks were expected to cut rates and that led to capital appreciation for bonds. I think there's still a role for core fixed income in a portfolio. All of our diversified portfolios have allocations to core bonds still, just less so than we probably would have 10, 15, 20 years ago.

Ptak: That all make sense. What gives you confidence that the alternatives that you might look to for a portion of, say, the equity or fixed-income sleeve of a portfolio, that they'll better withstand some of the conditions that you described, rising rates in particular?

Huber: We use an ensemble approach to developing an alternatives allocation. And we have some strategies that might have low-to-modest correlation with stocks or bonds, others that are pretty structurally uncorrelated. So, it might vary by one strategy to the next. But generally speaking, I think the types of things that we're interested in exploring tend to be things that are more risk-premium based. And so, we focus less on alpha-driven-type of alternatives, but more on different types of what we might want to call alternative-risk premia or alternative betas in some sense, where there's some economic or behavioral intuition as to why you should expect to make money in the strategy over time.

It doesn't mean that it's got a direct 100% confidence relationship with how it might perform in any type of stock or bond environment. But generally speaking, things that have a history of low correlation to stocks and bonds, some more so than others during when you want diversification the most--trend following would be a good example of something that's historically been pretty good at delivering positive or better relative returns in prolonged bear markets than other types of alternatives. And then, you have other things like cat bonds, or catastrophe reinsurance, that is structurally untethered from macroeconomic and other kind of financial variables. It's really an entirely different asset class altogether. And so, that gives you a really powerful diversifier in many ways. So, it varies. We have some alternatives that we do expect will probably not do as well as others during particularly liquidity-driven corrections, but at the same time, can still be diversifying over longer periods of time as well.

Benz: I wanted to ask, and I suppose it depends on the type of alternative in question. But where do you pull from? If you're suggesting that a client put X percent in alternatives, does that come out of the equity allocation or out of the fixed-income allocation typically?

Huber: I think it definitely depends on the specific alternative. But where we tend to land based on the mix that we have today, and I think based on the opportunity cost or lack thereof, and bonds, is that we find ourselves about three quarters or so of our alternatives coming from the bond allocation. And so, we are carving a little bit from the stock side, but it's predominantly from the fixed-income side. That might not be the case for how others do it. And I think again, it speaks to what are the types of alternatives you're including, how well diversifying are they to equities? If we were to be including an asset class like private equity as a target allocation, which we don't today, that would be something that would largely come from the equity sleeve, if not completely from the equity sleeve. Ultimately, we want to examine the risk-return properties, the downside potential, and the historical correlations of the different alternatives we're evaluating. But more often than not, it's leading us to take more from the bond side today.

Ptak: I think we want to get into the practical aspects of using alts in a moment here. But I neglected to ask earlier about inflation. And obviously, it's very topical right now. I'm sure you're getting no shortage of questions on it. But the extent to which that might inform decisions that you would make to use alternatives in a sleeve of a portfolio, has that become an increasing emphasis for you? And maybe the first question is, is inflation an increasing concern for you and your colleagues within your firm's investment office? And then, to the extent that it has been, how is that informing your selection of investments for clients that you might be working with?

Huber: I think certainly inflation is a higher risk and a higher concern today than maybe it was a handful of years ago. But I think we'd also be silly or foolish to try to say with any high degree of confidence that we know where inflation is going over the near and long term. But again, back to the point earlier about knowing that if there's one variable that can really disrupt those traditional stock-bond-focused type portfolios, it is high and persistent inflation. And so, I think you want to have a subset of your portfolio carved out to things that either have some positive sensitivity to rising inflation or just a structural noncorrelation to inflation as well. So, I think we've got elements of both in our portfolios. It’s less about us making any sort of bold prediction, but more of just, let's be prepared for a wide variety of different types of economic regimes.

Benz: So, how do taxes figure into this? Does the tax status of the assets inform some of the choices you'll make about whether to allocate part of a client's portfolio to alternatives?

Huber: Absolutely. That's the one key difference when it comes to allocating alternatives for individuals as opposed to institutions is the after-tax numbers are what's important. We focus a lot on that when we're making these assumptions. Most of the clients we work with, we tend to manage several accounts for their households usually--not in all cases, but many cases, it's a couple of trust accounts or taxable brokerage accounts, or a traditional IRA or a Roth IRA--and we will usually have anywhere from three to six accounts for a typical household. And so, this idea of asset location, I think, is particularly paramount to where we house the alternatives inside of their different account types. Because we know--this is not a blanket statement, but generally speaking--I think alternatives tend to be more tax inefficient than core stocks or things like muni bonds.

And so, where we can, for things that have a high propensity to, maybe they're high turnover, so they distribute a lot more capital gains, potentially short-term capital gains, or things that have a high level of current income that's taxed at ordinary income rates. We want to try to do our best to house those inside of tax-sheltered accounts where at all possible. Sometimes it's not always a possibility. But that's one way that we address the inherent tax inefficiency of certain alternatives. That being said, even in a situation where we have only taxable money for a client, it can still make sense to include some of these alternatives. It just might mean that the sizing of those goes down a little bit relative to what we would do if we were working only with an IRA account. So, absolutely, after-tax returns are what matters. And things can get a little bit complicated from a tax standpoint with different types of alternatives, but that doesn't necessarily mean they should be dismissed if we're only looking at a taxable account.

Ptak: I wanted to ask you more generally about trade-offs and retirees you work with who are maybe good candidates for alts. But how do you set expectations with them about the trade-offs that they'll have to make? Obviously, taxes is one of those trade-offs. It could also be liquidity. Some of the strategies that you might allocate them to might be less liquid than they're accustomed to with, say, standard fund or ETF investments. So, how do you have that conversation with them and set expectations so that there's not a mismatch?

Huber: That's exactly what asset allocation is, is managing trade-offs of different types. So, when we're introducing alternatives relative to a client who might be accustomed to a more traditional mix, there are a lot of things to factor in. First is, you're going to look different than the "benchmark" that you might be tethering to. So, it's getting comfortable with a portfolio that's got maybe more line items. And this notion that you're trying to give a higher degree of confidence in winning the war, but it might mean you lose a few more battles along the way in terms of individual line items having negative performance or disappointing performance over shorter-term periods. So, that's one element of it.

The other is costs. There's not a lot of alternatives that have Vanguard-like fees. And so, in a world where a lot of folks are accustomed to truly rock-bottom expenses from their index funds that they use for stocks and bonds, some of the expenses can be a little eye-popping when you look at different alternative funds. And so, you have to really put a strong lens on fees in the space and make sure that you're confident you're going to get more in return for that increase in fees. But it is a little bit of a head-scratcher for those that are accustomed to index fund investing and cheap funds.

Taxes is another one, as we've gone through a few moments ago. And then this notion of liquidity--I think you can still build a good mix of liquid alternative strategies. But there are a handful of categories that you can't really do inside of a traditional daily liquid 40 Act structure like a mutual fund or an ETF. And so, there are certain asset classes that if you want exposure to them, you have to be a bit open to less-liquid fund vehicles--it could be true private fund-type structures like LPs, or it could be things that sit in between that might still be 40 Act regulated but have periodic liquidity over a quarterly basis as opposed to daily, things like interval funds or tender offer funds, things of that nature. So, there are a growing number of different wrappers for different asset classes. I think it really just becomes a function of what the clients' goals are, what their tolerance is for illiquidity, what their income needs may or may not be. And so, we try to factor all that in when we're trying to come up with an appropriate allocation recommendation for a client.

Benz: You've said that one of the reasons you wrote the book is because you do get a lot of questions from clients about alternatives. What do they tend to ask? Is it mainly performance related, like, why are you recommending this asset even though its track record doesn't look that great? Or are the questions about things that they own or that they don't own but maybe wish they did? What do the questions tend to be about?

Huber: Some of it's just very basic, like, “Tell me more about what this is; I don't understand what's going on underneath the hood.” And so, it's incumbent on us as the advisor, particularly in my role and my team's role, is to help advisors tell the story without getting too far in the weeds, without getting into investment jargon when they're trying to translate an inherently more complex asset class to an end client that might not have the sophistication level to understand that at a very deep level. We want to make it understandable, so they can get a sense for why should I expect this strategy to make money over time, why am I paying a premium for it, what role does it play relative to the other assets of my portfolio?

And I think the other element just has to do with the questions that come up is always going to be a bit of a function of the market environment you're in. When you've got a backdrop of a pretty steady bull market for stocks, anything that's detracting from performance, whether it'd be bonds, or different types of other diversifiers, you're just going to have a closer lens pointed at them. Our mutual friend Brian Portnoy has coined the saying of, “Diversification always means having to say you're sorry.” And so, the more line items you have in a portfolio, the more likely it is there might be something you had to say sorry about.

Part of it is getting advisors comfortable communicating about the portfolio as a whole as opposed to the individual components. Because we know that not every asset plays the same role, similar to a sports team. If you look at a basketball team, and you look at the newspaper the next morning after a game, you could look at the points for a certain player. And if they had no points, you might assume they had a bad game. Then if you look a few columns over, and they had 10 rebounds and 5 steals, that's a pretty valuable contribution to that team. And it's just a different role at a different position he might play at. I think the same goes for alternatives. If your expectation is that something like managed futures, for example, is going to outperform your stocks, you're likely going to be disappointed because that's not what it's in the portfolio to do. So, I think a lot of the questions that we get are just, again, clients just want to understand more of these things that are a little bit more novel to them that they've not had experience owning in the past. And it's our job to get them a little bit more comfortable with the uncomfortable.

Ptak: What about the behavioral aspects of alternatives? Do you find that incorporating alts into a client's allocation makes things easier from a client-behavior standpoint? Are they more manageable per se? It seems like it could go either way. But has your experience led you to conclude that maybe clients are likelier to stick with the plan than otherwise?

Huber: I think it does cut both ways. I think for some clients the additional line items, the additional tracking relative to common indexes or benchmarks makes it a little bit more challenging to hold for a certain audience. That being said, I think for the clients that have really strong views on where they think the stock market is headed, or they don't want to own any more bonds because rates are so low, there's more of an openness there to other types of asset classes--especially if we've got clients that maybe come into a lump sum that they're looking to allocate, but are hesitant to, because they're afraid of putting it into stocks at all-time highs, or they don't want to put it in bonds and earn basically nothing in yield. And so, I think having a dedicated allocation to other types of investments gets them a little bit more comfortable putting that money to work as opposed to sitting on the sidelines and cash where we know that the real returns are going to be negative.

So, I think both cases come to the surface, but probably more so the former in terms of it being more of a behavioral impediment. But that's the challenge that advisors face. That's a large part of why I wrote the book is to help advisors try to address those challenges.

Benz: As someone who has done it a lot, what tips do you have for advisors or individual investors when it comes to evaluating a liquid alternative investment strategy? Maybe you could take a couple of examples like managed futures which you write about in the book. What are the hallmarks of a good fund in those areas?

Huber: I think it's interesting with alternatives in that, in some cases, there's actually a very limited number of managers offering strategies in the asset class, especially in 40 Act plan. Using reinsurance as an example, I can count on one hand the number of managers that have dedicated reinsurance funds, whether they be daily liquid mutual funds or interval funds. And so, it's a limited set of competition. But that being said, just because there's only one game in town or two games in town doesn't mean you should lower your bar for quality when it comes to manager and fund selection. And so, I think what we look for is, especially in areas where we're not just clients, but ourselves as advisors need to get really educated on is, you want to look for a strong commitment to education in partnership that the fund provider has.

I think you also want to have reasonable expenses relative to your peers. It doesn't have to be the rock-bottom, lowest-cost fund option in a category. But I think you want to put a close magnifying glass on fees and make sure that they are reasonable and not overcharging.

Another area, and I think this is key for even equity fund managers and in other types of categories, is that this notion that management's eating their own cooking, and that they're heavily invested in their own funds as well. And I think just having personnel, people actually managing the day-to-day portfolio, are people that have extensive experience and expertise in a particular asset class, especially those that are quite niche in nature. You want to make sure this is not just a traditional large fund complex who's saying, “There's an appetite for liquid alts, let's launch a fund just because we think we can grab some assets here.” I think we saw a lot of that type of behavior following the financial crisis when liquid alts were the hot new thing, and there was just a flood of products and supply that got brought to market. And I think if we’re being honest and looking in hindsight, a lot of that was just “me too” stuff where everyone just wanted to participate in this asset grab, and there were a lot of firms that probably didn't have the background or wherewithal to be developing some of these alternatives—they just wanted to throw their hat in the ring, and maybe they've got a good relationship with advisors and other categories and figure it's an easy sell.

Since that universe has whittled down over recent years--liquid alts aren't as popular as they were in the early 2010s--I think a lot of the “we-cans” have probably folded both on the provider side as well as the advisor side. But that makes me a little bit more optimistic in that what's left over is probably of a higher average quality than what was there 10 years ago, not to say that every alternative is worthwhile. That's certainly not the case. In fact, I would argue the opposite and that there's a lot more layers of due diligence that advisors need to be doing on alternative funds relative to traditional. But I'm optimistic in that you're starting to see some lower-cost options come to market and I think just some staying power from those that have weathered the storm and continue to execute properly.

Ptak: Not to presume anything, but I would imagine one of the reasons we don't see more providers in the space--you could argue that it's incentives, and perhaps it's more lucrative for them to offer a version of a strategy in another wrapper where they're more handsomely compensated, I should say. Which leads to my next question: When investing in liquid alts, how do you ensure that you're not getting a lower-octane version of the same strategy that's offered to, say, limited partners? What are the kinds of questions you and your team would ask to try and ward off that risk?

Huber: I think it's ferocious, trying to really wrap your arms around what, for the non-liquid version--like what they're doing for LPs--what does that look like? What's the universe of securities that they're fishing in? Is it the same universe that they're using in 40 Act? How much leverage and shorting and derivatives exposure is there in the main, call it, higher-octane fund, and do the limitations in the 40 Act really inhibit their ability to deliver a similar type of strategy in a more liquid, investor-friendly fund structure? There are instances where that has been the case, where it is quite watered down, but I think there's also some scenarios where it might be a little lower octane, but that might not be a bad thing. In other words, the lower-octane version can still be good. Maybe it's not quite as good as the less liquid, but that's the trade-off involved. If someone really wanted that higher-octane version, if they've got the means and can meet the minimums, then maybe that's the best route to go is toward that LP if they can tolerate the additional complexity that comes with that type of fund structure. I think it's definitely something you want to pay close attention to. But there have been instances where even the lower octane can be valuable in a portfolio.

Benz: Within the alt space, you often hear it said that the best managers are the ones you can't get access to. I'm sure there's some hyperbole there. But how real is this challenge? And how does it inform how you approach the due-diligence process? Would you ever ask why, if the manager is so good, they might be offering access to the strategy?

Huber: Absolutely. I think your antennas should always go up when it's put in front of you. It  brings out the old quote of "I don't want to belong to any club that will have me as a member." If Renaissance Technologies sends me an email one day asking if I want to get into the Medallion Fund, I'll probably know that they've tapped out and all their alpha has disappeared.

I think it should raise an eyebrow. At the same time, I think there's a lot of asset managers that have historically been institutionally focused that naturally want to diversify their client base, similar to how we want to diversify our client bases as an RIA. I think there's an element of truth to that. But at the same time, it doesn't always have to be the case that just because a great manager or one with a great track record is coming to you, it doesn't mean that they've exhausted all their options. I think the private wealth opportunity is pretty humongous, especially when you've got firms like our size at Savant and other mega, larger RIAs. These are pretty large pools of capital. So, there is an attractive opportunity to the asset manager, I think, to try to broaden their scope a little bit and see if there's an audience in the wealth management space in addition to their core institutional client base.

I think it's hard to say completely one direction or another. The last point I'll make there is just that there's also some really niche truly capacity-constrained type asset classes out there where large institutions probably can't allocate to it, because the opportunity set is too small. So, there might be some managers that are better equipped for the high-net-worth and ultra-high-net-worth and family office space, as opposed to the large pensions and endowments and sovereign wealth funds and things like that. It depends on the strategy as well.

Ptak: Since you mentioned capacity, I know that you have four Cs that you use as part of a construct that you use, and maybe you can review what those four Cs are, but one of them is capacity. And so, my question is, do you have a particular capacity limit in mind before you're allocating to a manager? And if so, how do you arrive at that estimate?

Huber: First, I'll start with that 4 Cs of investment cost. That's a construct that I talk about in the book, because as we alluded to earlier, alternatives are generally more expensive than traditional asset classes. And so, if you're accustomed to rock-bottom expenses when you're paying any premium above that, you want to understand, what am I paying for it? It's this notion that--in a perfect world, yes, all else equal, low cost is better than high cost. But all else is not equal in investing. And so, we want to have a framework for understanding when does it make sense to pay up potentially for a certain type of investment?

The 4 Cs that I came up with, one being capacity--things that have lower capacity generally tend to charge higher fees, because they are just limited in terms of how large the fund can grow. That's why Vanguard has got probably certain asset classes they'll never get into, because while a $5 billion fund might seem like a great AUM level for some managers, for Vanguard or BlackRock, it's a drop in the bucket. So, there's probably certain capacity-constrained areas that they won't even ever entertain, because there's only so much that they can raise there. So, capacity is one.

Craftsmanship is another. And this idea that some strategies, like certain indexes--like market-cap-weighted indexes--that's pretty straightforward from a design and implementation standpoint. But there might be other strategies, quantitative strategies, that require a lot more craftsmanship, both in the design of a portfolio and the ongoing trading and execution so that you can mitigate slippage.

The third C is what I would call contribution, which is really more things like correlation--what is the asset class contributing to the portfolio as a whole? So, something that is highly diversifying that has a compelling risk-return story--that's something that's valuable to a portfolio. So, it's probably worth paying up a little bit for that, and that's something you want to be mindful of--the things that have a higher degree of contribution might be worth that extra cost.

And then, the fourth C being complexity. So, things like catastrophe reinsurance, that's a very, very specialized type of domain expertise to manage portfolios in that category. There's not a lot of personnel that have that skill set to do so. And so, when you have a skill set or a talent base that's in high demand but low supply, then they likely are going to command a premium as well. So, those are the 4 Cs that I have for investment cost. It doesn't mean you should always pay up in those instances. It's just a framework for getting a sense of when there might be higher costs involved and when they might make sense.

So, to your other question: How do we think about capacity when we're making an asset class recommendation? It's not a hard science. But first, we want to have a sense of how large is the asset class that we're allocating to and how much money is this fund looking to raise? I think another component is whether or not the fund in question is more beta-focused or more alpha-focused? How much of the fund's value proposition is just delivering broad exposure to the underlying risk premium versus how much is that idiosyncratic manager-specific component? Because that might have an impact on capacity as well. And I think for us at Savant, we generally want to have idea of if we were to make an allocation of X part of our portfolios, how much are we going to make up of the aggregate AUM of that fund? And we've got some kind of internal limitations where we might start to get uncomfortable if we're too large of a portion of the fund’s AUM. And to the fund's structure--how much control does the manager have over inflows and outflows; do they have the ability to soft or hard close the fund that might vary by the type of fund? An ETF can't really impose a soft or hard close on new assets, whereas something like interval funds, they can have tighter controls on when to let people in, when to let people out. And so, that might influence what capacity levels are appropriate as well. Hopefully that answers your question.

Benz: It does. I want to ask about hedge fund beta. I know you're a believer in innovation and factor investing. I don't think you addressed it at length in the book. But do you think quantitative approaches to alternative investing will catch on eventually? And, if so, what will it take for them to break through apart from good performance?

Huber: I look at them in two camps. When I hear hedge fund beta, I think of things like hedge fund replication, which I'm generally not a huge fan of. But then, when I also hear hedge fund beta, I think of what I would bucket as alternative-risk premia. So, things that have historically been core hedge fund strategies that are adaptable to more liquid systematic approaches that maybe won't be generating the returns of the early years of the hedge fund era, but at the same time, can still deliver very valuable diversification and decent enough returns to warrant inclusion inside of a portfolio. And so, we're generally fans of quantitative systematic approaches over more fundamental just because we can better have a grasp on what's going on underneath the hood and more transparency about what the exposures are. Whereas it can be a little bit more nebulous when it comes to a more idiosyncratic manager-driven approach. So, we are fans of quantitative approaches, and that's not just in our alt sleeve, but we have very much a quantitative kind of factor bias within how we manage equity portfolios as well. Like anything, it's hard for something to catch on when you're coming off of a period of relatively poor performance. But assuming that that subsides, I think there is value to more of these quantitative approaches, because I think, generally, they tend to get offered at lower and more reasonable fees. And I think that's a good thing.

Ptak: I wanted to ask about one of the more original features in the book, which is great. It's a periodic table that you came up with of alternative investments. Can you describe that for our listeners what it is you came up with and why you think it could be useful to those who are trying to make sense of the alternatives universe?

Huber: This was actually a really fun design piece to come up with, and it actually predates the book. I was really excited to include it in the book, because I think it helped tell the story I was trying to tell about just how our notion of building diversified portfolios and what the underlying components of those are, is very much a great analogy to the periodic table of chemical elements that we remember from high school. The book starts with this idea of, why is it 60/40 facing headwinds? But I also wanted to analyze alternatives from a different lens, which is what if we assume normalized interest rates and fair equity valuations, is there still a role for alternatives? In other words, the inclusion of alternatives shouldn't have to be predicated on the fact that stocks are expensive, or the bond rates are low. It's just this idea that many people want to build balanced portfolios that achieve a reasonable rate of return and are built to withstand a wide spectrum of different types of environments. And so, if we can include things that have really unique and diversifying return streams to them, that's ultimately something that I think can make the overall portfolio more resilient. And the reason that's exciting today is because there's just more tools in our tool kit, as allocators and as advisors, than we had 10 years ago and 20 years ago. We're continually seeing innovation and evolution in not just our understanding of what makes markets tick and what are valuable contributors to portfolio returns over time, but also just the access. I hate to use the word “democratize” because I think it gets quite overused today. But I don't have a better word, so I'll say it.

I think you are seeing that. Liquid alts are one step in the right direction, but certainly have their flaws. Things like interval funds--the structure itself I think was first created in the early ‘90s--but that really only started to gain wide adoption in the past few years. But that opened up a sort of middle ground, where you can get some illiquidity and some illiquid investments in a portfolio, but you don't have to extend out beyond the 40 Act space. So, that's interesting to me. I think you're seeing a ton of innovative tech platforms out there that are in some cases offering direct-to-consumer access to different alternative categories through apps and platforms where they're bypassing the fund complex completely. And then, I think you're seeing the emergence of wealth management-oriented private alternative platforms, things like iCapital, CAIS, that are trying to make the onboarding and allocation process for advisors to things like private equity and private credit and real estate and hedge funds a bit more streamlined, lower minimums, things like that. So, I think you are starting to see more ability for a large audience of investors that previously were not privy to certain asset classes become more able to further diversify their portfolios. So, it doesn't have to be for everybody. But I think in terms of what you're seeing the trend there, that strikes me as one of those kinds of directional arrows of progress, where it's only going to continue to get more improved for investors in terms of what options they have to build a diversified portfolio.

I thought the periodic table construct was a great way to think about what are the elements today and what role do they serve in a portfolio? So, if you look at the image in the book, each square represents a particular asset class or subasset class, and each square has one or two letters in them and those letters represent the primary and secondary objectives that you would have for that asset class. It could be capital appreciation; it could be inflation sensitivity; it could be income generation; it could be just general diversification. I tried to identify that for each square in the box--what role this would play in a portfolio?

And I think what's cool about the periodic table is if you look at the history of when different elements were added, we look at the periodic table in present day, and we see this beautiful picture with 100 to 116 different elements in it. But it's important to note that some of those elements were only discovered in the past century or two. If you looked at the periodic table of chemical elements in the 1700s, it was much smaller, maybe a couple dozen elements. Much like scientists have continued to break new ground and make new discoveries there, same thing goes for investors--that we're always continuing to move down the frontier and identify new asset classes and strategies that might have a reasonable chance of making money.

Benz: Earlier in the conversation, Phil, you mentioned that the alts allocation is often coming out of fixed income. Have you and the firm thought about annuities? Do you use annuities for clients who are retired as a component of their fixed-income allocations? Can you talk us through how you approach them?

Huber: We don't approach them in any sort of size or scale today. We certainly have clients that have annuities. It's tended to be more one-off scenarios. So, it's not anything we're doing as a strategic part of our allocation today. That being said, it is kind of a research project, I would call it, for the next year where there have been a handful of advisors that really are starting to see some potential value in annuities from a sequence of return and retirement risk framework. I think it will be a collaborative effort between our planning team and our investment team to try to make a determination as to whether or not it makes sense to continue exploring annuities and what role, if any, they play inside of our portfolios. But today, it's historically just been either things that clients already own that we help them oversee, or various one-off scenarios where there's been a reason to allocate there.

Ptak: Another category I was curious to get your take on is direct indexing. What has been your experience with that? And is that becoming a bigger part of what you're offering to clients?

Huber: It is.It's interesting. We've addressed customer direct indexing a couple of ways within Savant. You're familiar with Patrick O'Shaughnessy. I think you even had him on to talk about Canvas.

Ptak: We did.

Huber: So, at Huber Financial, we were one of the pilot firms with Canvas, one of the first five to beta-test that platform and put client money on there. They've done a wonderful job building that. And obviously, there's been a ton of activity in that space, including in terms of acquisitions. It's clearly a service that is gaining rapid popularity and seemingly will only continue to grow. A lot of major players in the asset-management industry are getting a foothold in direct indexing today.

I think there's definitely some great use cases where that's appropriate. Interestingly enough, Savant, prior to us joining, had a history of their own of doing direct indexing but doing it in-house through the use of tax-optimization technology. We offer it a couple of ways. We have clients that are using Canvas, where we outsource that to O'Shaughnessy and the work that they do. And then, we also have clients that we've been doing it in-house for as well. So, obviously, I think the biggest benefit to direct indexing for most people, or at least the perceived value-add that comes from it, is that more-granular ability to do tax-management and tax-loss harvesting, or donation of appreciated securities. Just having a more granulated way to manage taxes or time--that's a key benefit.

And I think more and more, we're increasingly seeing clients that have very specific values or views that they want to express within the portfolio. I think that's an audience that is just starting to learn that that sort of thing is even available to them. ESG is certainly the buzzword of the last couple of years in the industry it seems, almost like smart beta was a few years before that. And I think there's just more awareness about ways to incorporate personal views around things like the environment or other social values, and so on, but to do it in a very targeted way where mutual funds and ETFs have very broad-based ways to incorporate those types of exposures-- direct indexing as a way to do that at a very, very narrow granular level, depending on what someone might be interested in.

And then, the other key benefit is this idea of efficient tax transition of someone's legacy portfolio--when someone comes over with a number of concentrated stock positions or things like that--to really help them work through a thoughtful transition of that to a more diversified mix over time. So, yes, I think the interest is certainly warranted. We're fans of having that capability to offer our clients and we think that will only become a bigger part of our practice as time goes on.

Ptak: Well, Phil, this has been a really enlightening discussion. Congratulations on the new book. And thanks again for being our guest and sharing your insights. We really appreciate it.

Huber: My pleasure. I've got such a great admiration for both of you personally and professionally. And being an avid listener of the show, it really is an honor to be on your site. I really appreciate you having me on and for your support. So, thank you very much.

Benz: Thanks so much, Phil.

Ptak: Thanks for joining us on The Long View. If you could, please take a minute to subscribe to and rate the podcast on Apple, Spotify, or wherever you get your podcasts.

You can follow us on Twitter @Syouth1, which is, S-Y-O-U-T-H and the number 1.

Benz: And @Christine_Benz.

Ptak: George Castady is our engineer for the podcast and Kari Greczek produces the show notes each week.

Finally, we'd love to get your feedback. If you have a comment or a guest idea, please email us at TheLongView@Morningstar.com. Until next time, thanks for joining us.

(Disclaimer: This recording is for informational purposes only and should not be considered investment advice. Opinions expressed are as of the date of recording. Such opinions are subject to change. The views and opinions of guests on this program are not necessarily those of Morningstar, Inc. and its affiliates. Morningstar and its affiliates are not affiliated with this guest or his or her business affiliates unless otherwise stated. Morningstar does not guarantee the accuracy, or the completeness of the data presented herein. Jeff Ptak is an employee of Morningstar Research Services LLC. Morningstar Research Services is a subsidiary of Morningstar, Inc. and is registered with and governed by the U.S. Securities and Exchange Commission. Morningstar Research Services shall not be responsible for any trading decisions, damages or other losses resulting from or related to the information, data analysis or opinions or their use. Past performance is not a guarantee of future results. All investments are subject to investment risk, including possible loss of principal. Individuals should seriously consider if an investment is suitable for them by referencing their own financial position, investment objectives and risk profile before making any investment decision.)