Betterment in Kiplinger’s Personal Finance Magazine
By Thomas M. Anderson, Contributing Editor
Abbas Haider Ali wanted to put $25,000 into the stock market. But instead of transferring the money to a mutual fund, the Washington, D.C., technology executive decided to invest with a money manager whose every move he had been tracking for three months through a firm called Covestor. Once a day, the online service shows you the stock trades of more than 130 money managers, a mix of professionals and amateurs, even if you’re not a customer. If you find a manager you’re comfortable with, you can see his or her trades in real time and mirror them in your brokerage account.
Here’s how it works: You check out a manager’s holdings, moves and performance on the mirroring service’s Web site. If you like what you see, you give the service permission to execute the same trades in your brokerage account in the same proportions that the manager makes. So if the manager puts 5% of his or her portfolio in, say, Netflix, the service will buy a 5% position for you in your account. For the privilege, you pay a fee of 0.5% to 2.3% per year on the amount of money you invest with the service to follow the manager. The size of the fee, which is split between the manager and the mirroring service, usually depends on the complexity of the investing style and the popularity of the manager you choose. By comparison, the average expense ratio for diversified U.S. stock funds is 1.35% annually.
The mirroring firms say their services give ordinary investors more transparency and control than they would have with a traditional mutual fund. That’s because you can see every trade a manager makes in your brokerage account almost instantaneously, as opposed to waiting for a fund to issue its quarterly list of holdings. You can also create a list of stocks not to be purchased for your account, even if your manager buys them, or simply sell a stock at any time, even if the manager is hanging on to it.
Most clients of Covestor and its main rival, Wealthfront, are treading lightly. The average account balance for both is about $45,000. Ali was interested in Covestor because of the novelty of its approach to money management, and he wanted to see whether the manager performance posted on the site would hold up in his account. Ultimately, he gained the confidence to invest his money with the service because he was able to closely track his manager’s trades. “I used the most speculative money in my portfolio to see if this really works,” says Ali, who invested to mimic the trades of Vivian Lewis, editor of the newsletter Global Investing and a specialist in foreign stocks that pay large dividends.
Covestor and Wealthfront (formerly known as Ka-Ching) have been in the mirroring business since 2009 and are the largest players. Others with similar services are TD Ameritrade, which offers mirroring accounts through the AutoTrade service of its thinkorswim online brokerage, and Ditto Trade, which launched a mirroring service in October.
In some ways, these services are similar to separately managed accounts, which have been a fixture in the investing world since the 1970s. SMAs are professionally managed products that brokerage firms offer to well-heeled investors. With SMAs, you own the securities directly, rather than shares of a fund, and you can check your holdings and trades in real time. But the minimum initial investment with an SMA is typically $100,000; you can open an account with Covestor or Wealthfront with just $10,000.
Both Covestor and Wealthfront are investment advisory firms registered with the Securities and Exchange Commission. If you want to invest with either one, you must open an account with an online broker, which takes custody of your money. To use Covestor, you open an account with Interactive Brokers. Wealthfront works with Interactive Brokers and Fidelity brokerage accounts. (The minimum to open a Wealthfront mirroring account at Fidelity is $25,000.) As registered advisers, Covestor and Wealthfront do background checks and verify the trading records of the managers they offer, and the sites are liable for their conduct.
At last report, Covestor had 178 investment options; 62 are managed by registered investment advisers and the rest are unregistered. “We don’t want to be overrun by professionals,” says Perry Blacher, Covestor’s chief executive. Among the unlicensed investors is Robert Freedland, an optical surgeon with a bent for value investing. Another unregistered manager, but one who is clearly no amateur, is Dan Plettner, a former closed-end-fund analyst at Morgan Stanley. He runs several portfolios that regularly appear on Covestor’s leader board. The only way most people can invest with Freedland and Plettner is through Covestor.
Nearly half of Covestor’s managers have trumped their chosen yardsticks, but most have less than two years’ worth of trades because the service started in 2009. With such short records, it’s difficult to tell whether the top performers are good or just lucky.
Wealthfront is shunning amateur managers. As of early June, it offered 41 registered advisers who have passed its selection process. The company scores its money managers on three factors: the returns they generate relative to the risks they take, how consistently they stick to their stated investing style, and their research process. Wealthfront says that an equally weighted index of their managers’ performance returned a cumulative 27.9%, net of fees, from October 19, 2009, through April 18, 2011. That is 4.5 percentage points better than the return of Standard & Poor’s 500-stock index. Wealthfront, however, does not show how the average client’s mirroring account has performed, as Covestor does. Nor does Wealthfront compare its managers’ results against the average performance of mutual fund managers with similar investing styles. It only lists the performances of benchmarks, such as the S&P 500, for comparison.
One of Wealthfront’s top-performing managers is Yale Bock, a retired teacher who operates a pawnshop in Las Vegas and runs money on the side. Over the past five years through June 1, according to Wealthfront, his portfolio earned an annualized 13.6%, compared with 0.8% annualized for the S&P 500. “My style is growth at a reasonable price, and I like to stick to my premise for buying a company,” says Bock, whose portfolio held just 13 stocks at last report. Bock joined Wealthfront in March 2010 and has attracted $1 million in assets through the Web site (his performance data predate his affiliation with Wealthfront).
Covestor and Wealthfront are tiny compared with traditional money managers. Covestor does not disclose the amount of assets under management, and Wealthfront has just $27 million, making it a speck in the asset-management world (by contrast, assets in U.S. mutual funds total $12.5 trillion, and separately managed accounts hold $536 billion). As far as investor Ali is concerned, though, small size has at least one advantage. “Every time I call Covestor, I speak to the same person and he knows me,” he says.
Mirroring services will remain investing sideshows until their managers generate longer records and demonstrate that they can perform better than traditional forms of active management. But you don’t have to pay anything to browse the marketplace of aspiring talent at the mirroring services. Covestor offers a trial account that lets you see how its service works, and you can review manager picks on Wealthfront’s Web site free. Because it’s so hard to find great investors, any service that broadens the pool of potential stars is a welcome development.
An Online Manager for Indexers
You don’t have to be a fan of active stock pickers to use an online money manager. Betterment is a brokerage that lets you transfer money with ease from an online savings account to preassembled portfolios consisting of low-cost index-based exchange-traded funds. Betterment’s fees range from 0.3% to 0.9% of assets, depending on the size of the account, and there is no minimum-investment requirement. The firm, which has $10 million in assets under management and more than 4,000 clients, uses six U.S. stock ETFs and two bond ETFs to construct its portfolios. The service is currently not available for retirement accounts. Betterment says it is working to correct that shortcoming, as well as to add overseas ETFs to its investing mix.