And Charles Stein �Mar­garet Collins

Bloomberg Businessweek (North America) - - Markets/Finance -

by Van­guard be­fore the plan is set in mo­tion. (About 40 per­cent of cus­tomers con­nect by video chat at some point.) The con­ver­sa­tion gives the ad­viser a chance to ask about other sav­ings or as­sets peo­ple have and to gauge their in­vest­ment pref­er­ences, says Karin Risi, man­ag­ing di­rec­tor and head of the retail in­vestor divi­sion at the com­pany.

Many of the Van­guard ad­vis­ers have a cre­den­tial as a fi­nan­cial plan­ner or are work­ing to­ward one. Cus­tomers need at least $50,000 in­vested at Van­guard to par­tic­i­pate, but only those with at least $500,000 to in­vest get a ded­i­cated ad­viser. Clients with less money could end up speak­ing to one of sev­eral mem­bers of a team when they call in.

The mar­ket for dig­i­tally based ad­vice is ex­pected to grow to $285 bil­lion by 2017, ac­cord­ing to re­searcher Aite Group. Mil­lions of baby boomers are near­ing re­tire­ment and need help fig­ur­ing out how to make the money last. At the same time, wide­spread ac­cep­tance of in­dex funds has helped make au­to­mated port­fo­lios pos­si­ble. In­vestors don’t nec­es­sar­ily look to ad­vis­ers to help them pick in­di­vid­ual stocks and bonds.

“We as­pire to serve hun­dreds of thou­sands of clients over time,” Risi says. In ad­di­tion to the $12 bil­lion from new ad­vi­sory clients since May, Van­guard has brought in $9 bil­lion from cus­tomers who were part of an ear­lier pi­lot pro­gram. The com­pany did not re­veal the num­ber of ac­counts.

At Sch­wab, three-quar­ters of those who’ve joined its au­to­mated ser­vice were ex­ist­ing cus­tomers. The com­pany over­sees $2.5 tril­lion in to­tal client as­sets, and by De­cem­ber it had at­tracted $5.3 bil­lion to In­tel­li­gent Port­fo­lios, with 63,000 ac­counts. Clients can reach out to the com­pany by phone or on­line, but it’s not re­quired, like it is at Van­guard.

“The star­tups are fac­ing an up­hill bat­tle,” says Scott Smith, a di­rec­tor at Cerulli As­so­ciates in Bos­ton. “They are go­ing up against firms with tril­lions of dol­lars of as­sets.”

Ex­ec­u­tives at both Bet­ter­ment and Wealth­front say there’s room for es­tab­lished com­pa­nies and pi­o­neers. Adam Nash, chief ex­ec­u­tive of­fi­cer of $3 bil­lion Wealth­front, which launched in 2011, says his com­pany fo­cuses on younger in­vestors with dif­fer­ent ideas about tech­nol­ogy and in­vest­ing while in­cum­bents are bat­tling for boomers’ as­sets. “Those older in­vestors aren’t look­ing for the same things,” he says. “We want to be the Ama­zon, the Netflix in this cat­e­gory.” Nash says 90 per­cent of Wealth­front cus­tomers are younger than 50, and 60 per­cent are un­der 35.

About two-thirds of the Van­guard ser­vice’s clients are near­ing re­tire­ment age or re­tired. Roughly half of those who signed up for Sch­wab’s robo are over 50, says Tobin Mcdaniel, pres­i­dent of Sch­wab Wealth In­vest­ment Ad­vi­sory. Of course, older savers are also where most of the money is.

Bur­ton Malkiel knows both sides of this new in­dus­try. The Prince­ton econ­o­mist’s book A Ran­dom Walk Down Wall Street cham­pi­oned the idea of in­dex in­vest­ing, and he spent decades on the Van­guard board. He’s also chief in­vest­ment of­fi­cer for Wealth­front. Malkiel says the robo-ad­viser trend is about the “Van­guardiza­tion of in­vest­ment ad­vice.”

As hap­pened with in­dex funds, cut-rate com­pe­ti­tion will push fees down for all kinds of ad­vice, and more peo­ple will be able to get help build­ing port­fo­lios. “The pres­ence of Van­guard and Sch­wab—con­sumer-friendly com­pa­nies—is a good thing, not a bad thing,” Malkiel says. hoops to even get any­one’s at­ten­tion.”

Such con­di­tions led the U.S. Depart­ment of Hous­ing and Ur­ban De­vel­op­ment in Fe­bru­ary to cut off rent sub­si­dies for more than 1,000 res­i­dents. Those fed­eral dol­lars were to be used to re­pay $12 mil­lion of bonds sold by the apart­ments’ owner, Global Min­istries Foun­da­tion. With­out that money, the bonds went into tech­ni­cal de­fault, push­ing their price to as lit­tle as 21¢ per dol­lar of their face value.

The GMF debts were mu­nic­i­pal bonds, govern­ment-spon­sored debt that of­fers in­vestors in­come free from taxes. Mu­nis may call to mind in­vest­ments in toll bridges and sew­ers, but they also in­clude bonds like GMF’S is­sued through “con­duits”—lo­cal agen­cies with few, if any, em­ploy­ees that ex­ist only to sell tax-ex­empt debt for a fee. With lit­tle re­spon­si­bil­ity for the projects they fi­nance—some­times in dif­fer­ent states—the au­thor­i­ties have raised money for pri­vately run nurs­ing homes, char­ter schools, and even amuse­ment parks.

“Con­duits have been a peren­nial prob­lem in the mar­ket,” says Christo­pher Tay­lor, the for­mer ex­ec­u­tive di­rec­tor of the Mu­nic­i­pal Se­cu­ri­ties Rule­mak­ing Board, the in­dus­try’s reg­u­la­tor. About 60 per­cent of muni bonds that de­fault are is­sued by such con­duits, ac­cord­ing to Matt Fabian, a part­ner at Mu­nic­i­pal Mar­ket An­a­lyt­ics.

The mar­ket for con­duit bonds is one of Wall Street’s most opaque niches. Seven days af­ter GMF is­sued a let­ter to the bond trustee about the de­fault, some bonds were sold in lots of $25,000 and $50,000 for as much as 10 per­cent

The bot­tom line Startup robo ad­vis­ers have pointed the way to cheaper in­vest­ment ad­vice. But an es­tab­lished player is tak­ing over the game.

HUD said the War­ren and Tu­lane

apart­ments de­te­ri­o­rated un­der

its own­ers


more than face value. Nei­ther the buy­ers nor sellers are known. The trades sug­gest that small­time in­vestors may not be get­ting im­por­tant in­for­ma­tion when they buy bonds. In 2009 the muni rule-mak­ing board launched a web­site for re­port­ing such in­for­ma­tion, but in­vestors may not know the records are avail­able.

GMF, which says on its web­site that it works “for the glory of God and the eter­nal wel­fare of mankind,” owns 10,500 low-rent apart­ments in eight states. It fi­nanced its pur­chase of the Mem­phis apart­ments through the city’s Health, Ed­u­ca­tional, and Hous­ing Fa­cil­ity Board. The agency’s head says that GMF had a good rep­u­ta­tion with the in­vest­ment com­mu­nity be­fore the de­fault.

Richard Ham­let, GMF’S pres­i­dent, says his or­ga­ni­za­tion has in­vested more than $3 mil­lion in the Mem­phis apart­ments, which were suf­fer­ing from crime and poor main­te­nance be­fore GMF pur­chased them in 2011. “Our man­age­ment team, in ad­di­tion to out­side con­trac­tors we en­gaged, worked hard un­der very stress­ful con­di­tions to mit­i­gate phys­i­cal de­fi­cien­cies on the sites,” Ham­let says.

GMF is a non­profit. Ac­cord­ing to its tax records, Ham­let was paid $535,000 in salary and ben­e­fits in 2014. He says that’s in line with his in­dus­try peers.

Con­di­tions de­te­ri­o­rated af­ter the GMF ac­qui­si­tion, fed­eral re­ports say. An April in­spec­tion of 30 build­ings and 25 units found “life-threat­en­ing” breaches in­clud­ing ex­posed wires and blocked emer­gency ex­its. Al­though GMF hasn’t missed pay­ments on the bonds, it’s likely to do so within two years un­less it can sell the build­ings, Stan­dard & Poor’s Fi­nan­cial Ser­vices said on Feb. 19. The end of HUD sub­si­dies put the bonds in tech­ni­cal de­fault. Ham­let says this “is the first bond de­fault I have had in my ca­reer in this space.”

Fed­eral hous­ing of­fi­cials have be­gun plan­ning to re­lo­cate res­i­dents of the War­ren and Tu­lane apart­ments. “I’m ec­static,” John­son-peter­son says. “I feel like it’s an op­por­tu­nity to be able to pro­vide bet­ter chances for my chil­dren and a bet­ter en­vi­ron­ment to raise my chil­dren.” �Martin Z. Braun Bloomberg with to­tal re­turns for the se­cond half of 2015 lost 3.6 per­cent on av­er­age. In the same pe­riod, the Stan­dard & Poor’s 500-stock in­dex earned a slight gain with div­i­dends. While global mar­kets have re­vived re­cently, en­dow­ments may strug­gle to make up for lost ground by the time their fis­cal year ends in June.

“At this mo­ment in time, it doesn’t look like it’s go­ing to be a fan­tas­tic year,” says Tim Jarry, chief in­vest­ment of­fi­cer for the Col­lege of the Holy Cross in Worces­ter, Mass. The pri­vate col­lege’s en­dow­ment saw a loss of 4 per­cent from July through De­cem­ber. In­vest­ments con­trib­ute to a school’s an­nual op­er­at­ing bud­get, though schools de­ter­mine spend­ing based on av­er­age re­turns over a few years. In­vest­ments used for di­ver­si­fi­ca­tion were mainly a drag. The $3.1 bil­lion Univer­sity of Wash­ing­ton fund, down 3.8 per­cent, was hurt by emerg­ing mar­kets. The Univer­sity of Iowa, with $1.3 bil­lion, lost 4.6 per­cent, thanks in part to global bonds and real as­sets, in­clud­ing nat­u­ral re­sources. Hedge funds, which can bet on a va­ri­ety of se­cu­ri­ties ei­ther ris­ing or fall­ing in value, con­trib­uted to the Univer­sity of Cal­i­for­nia’s 2.5 per­cent loss on its $8.7 bil­lion port­fo­lio.

En­dow­ments have ex­panded the range of their in­vest­ments to in­clude not only com­modi­ties and hedge funds but also ven­ture cap­i­tal and pri­vate equity, or buy­out, funds. This is the Yale model, named for that school’s leg­endary $26.5 bil­lion fund, which has earned a 10 per­cent an­nu­al­ized re­turn over the past decade. ( Yale hasn’t re­ported re­turns for the lat­est six-month pe­riod.)

De­spite this shift, there re­mains a per­sis­tent long-term per­for­mance gap be­tween large en­dow­ments such as Yale’s and smaller ones. Schools with funds of at least $1 bil­lion have earned 7.2 per­cent an­nu­ally over the past decade, com­pared with an av­er­age of 6.2 per­cent for those from $101 mil­lion to $500 mil­lion. “A one-point dif­fer­ence over 10 years is pretty sub­stan­tial,” says Ken Redd, di­rec­tor of re­search

“Our man­age­ment team, in ad­di­tion to out­side con­trac­tors we en­gaged, worked hard un­der very stress­ful con­di­tions to mit­i­gate phys­i­cal de­fi­cien­cies on the sites.” ——Richard Ham­let, Global Min­istries Foun­da­tion The bot­tom line Mu­nic­i­pal bonds don’t only fund govern­ment and big pub­lic works. Some­times the bor­row­ers are pri­vate groups with shaky projects. $12m

Value of bonds is­sued for the apart­ments By en­dow­ment size More than $1b 7.2% $1b to $501m 6.7% $500m to $101m 6.2% $100m to $51m 5.9% $50m to $25m 5.6% Less than $25m 6.0%

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