Stephen Cucchiaro Navigates Portfolio Allocation
The founder and CIO of Windhaven Investment Management talks about ETFs, actively managed passive strategies and risk.
Investing readily lends itself to nautical metaphors. But in the case of Windhaven Investment Management founder and CIO Stephen Cucchiaro, the imagery is especially fitting. From 1976 to 1980 Cucchiaro was on the U.S. Olympic yacht-racing team, winning national champion in his class in 1978 and the gold medal in the event at the 1979 Pan American Games. In his wealth management career, he has been at the helm of two major industry changes: active allocation to exchange-traded funds in separately managed accounts, and the emerging importance of independent registered investment advisers (RIAs), who have become a core client for the firm. In 2010 Charles Schwab Corp. acquired the Boston-based firm, then called Windward, further expanding its reach in the adviser and family office community. As of October, Windhaven had more than $18 billion in assets under management. Cucchiaro, who has a BS in mathematics from the Massachusetts Institute of Technology and an MBA from the University of Pennsylvania’s Wharton School, developed an investment philosophy that focuses on building and managing portfolios using elements of both active and passive strategies.
Institutional Investor: There is constant debate among RIAs over whether active or passive management is a better fit for retirement and multigenerational wealth planning. What is your firm’s take?
Cucchiaro: We’ve been working as a subadviser for RIAs, multifamily offices and other wealth managers for quite some time. What we advocate is actively managed passive vehicles. Our philosophy is that the markets are relatively microefficient but highly macroinefficient, meaning that in the publicly traded markets, it has become more and more difficult to beat an index by picking individual securities. So we are proponents of using exchange-traded funds and indexes to represent investments. Having said that, decisions need to be made about how much to invest in which asset classes. And that’s where we feel an asset manager can add a lot of value.
So, active allocation versus active management?
Sometimes when you just use the term “allocation process,” people do think in terms of static or fixed asset allocation and more traditional asset allocation routines. What we’ve found is that there is a lot of value to be gained by allowing some flexibility.
In terms of assets and regional or national markets, how diversified should investors be? Certainly, passive investors with holdings in U.S. equities saw spectacular returns last year.
It really pays to look outside U.S. stocks. We’ve had an unusual environment in which, since early 2009, the U.S. stock market has greatly outperformed all asset classes and all geographies. There has thus been a temptation for investors to think that maybe there is no longer a need for diversification or asset allocation: “Why not just put all of your money in U.S. stocks — they’ve been outperforming everything else for the past three to four years?” Of course, that’s exactly when people need to not be complacent, because one asset class outperforming for an extended period is rare. The pendulum will swing, making it even more important to be diversified.
Can you walk us through the risk management process you employ in the allocation process?
Our portfolios have a tactical component and a strategic component — the latter is where we play defense. We think of our tactical component as the opportunistic component, where we play offense. To that end, we identify which major global asset classes and industries are poised to do best, given the state of the global economy. We will make those asset classes overweight to generate alpha without necessarily adding to the risk. Then for us, the defensive part is what we call strategic allocation, where you, without focusing on any kind of market projections, think about a series of downside scenarios and which asset class you would love to own if a certain downside scenario came to pass. Then you do this for a second scenario and so on. And by identifying a collection of ETFs or asset classes that work in each of these bearish situations, you can have a collection of investments to protect. That’s what we call our strategic portfolio.
Indeed, “tactical” has been a buzzword in the adviser community during the overall market recovery of the past couple of years.
Over the years “tactical” has come in and out of favor because the practitioners have done a relatively good job picking tactical investments that worked or, from time to time, have done a poor job, and then the tactical portion has been out of favor. So in our opinion, there’s nothing necessarily generic about tactical approaches. All firms have their own way that they create their tactical approaches, and some will outperform and some will underperform, just as there are some people who do a better job picking stocks than others.
As an outside observer of sorts, you have a great vantage point on the wealth management industry. What are the key trends for wealth managers?
One observation I’ve made over time is the increasing bifurcation among wealth managers. There are some firms that have tended to do all functions in-house: the client relationships, the estate and tax planning, asset management, back-office functions — all in a single contained shop. Then there are wealth management firms that have decided to really focus on understanding their specialized estate, tax and financial planning and then have gone outside for asset management. Part of it is, I think, that it hasn’t been as “fun” to manage assets ever since the crash in 2008. Also, it’s hard to staff up and try to be good at so many different things. It can be an expensive business model to run. Because of this, there are a number of managers who maybe in the past tried to do everything in-house who have begun to take on outside managers. From my perspective, it seems that they may be better poised to grow because they can spend more of their resources on developing client relationships, rather than on just all the internal operations.
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