Animal Spirits Podcast - Talk Your Book: Insourced CIO

Episode Date: December 12, 2022

On today's show, we are joined by Joe Mallen, CIO of Helios to discuss what he's hearing from advisors in this environment, insourced vs outsourced CIOs, bond and equity attractiveness going forward, and much more!   Find complete shownotes on our blogs...  Ben Carlson’s A Wealth of Common Sense  Michael Batnick’s The Irrelevant Investor  Like us on Facebook  And feel free to shoot us an email at [e-mail] with any feedback, questions, recommendations, or ideas for future topics of conversation.      (Wealthcast Media, an affiliate of Ritholtz Wealth Management, received compensation from the sponsor of this advertisement. Inclusion of such advertisements does not constitute or imply endorsement, sponsorship or recommendation thereof, or any affiliation therewith, by the Content Creator or by Ritholtz Wealth Management or any of its employees. Investments in securities involve the risk of loss. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. The information provided on this website (including any information that may be accessed through this website) is not directed at any investor or category of investors and is provided solely as general information.)  Learn more about your ad choices. Visit megaphone.fm/adchoices

Today's Animal Spirits is brought to you by Helios to learn more about their insourced slash outsourced chief investment officer capabilities. Visit heliosdriven.com. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnik and Ben Carlson as they talk about what they're reading, writing, and watching. Michael Battenick and Ben Carlson work for Ritt Holt's wealth management. All opinions expressed by Michael and Ben or any podcast guests are solely their own opinions and do not reflect the opinion of Ritthold's wealth management. This podcast is for informational purposes only and should not be relied upon for investment decisions. Clients of Rithold's wealth management may maintain positions in the securities discussed in this podcast.

Welcome to Animal Spirits with Michael and Ben. Michael, I think people who base their financial knowledge off TV and the movies assume that you hire a financial advisor and they pick stocks for you. Back in the old days, that's how people thought it. It works. Some people might still think that's the way it is these days. Most financial advisors, especially if they're in a smaller practice, are financial planners. They're building financial plans. They're doing insurance and tax prep and estate planning and all these other things. And the portfolio is part of that. But for most advisors, they're not investment people. They're

not portfolio managers. They're not CFA's. Warren Buffett is not your financial advisor. No. Advisors do a lot of different things. So there are now programs and models and strategies where an advisor can say, I just want to do the financial planning stuff, and I want someone else to do the investment stuff for me. And that's what Helios does. They have an interesting model. We talked to Chris Schubert, their CEO before. I've never heard this insourced CIO. So I worked in the institutional world. There was an outsourced CIO model where we have an endowment or foundation or pension. We're not big enough to hire a team. We're going to outsource that to someone else. That was one of my original jobs I worked in. I was a consultant. We were

basically in outsource CIO, we would do asset allocation, we would create the investment plan, create all the guidelines. Was it all target date funds? It should have been, basically. That's the job I learned the importance of asset allocation, that asset allocation is more important than stock picking. Helios does this for a number of RAs and advisors and warehouse brokers. It's an interesting model because instead of saying, we're using this outsource CIO, here's the team we're working with. They work with the advisors and then they're basically behind the scenes. They do it on their own, and they help the advisors come up with their own models and plans. Interesting model.

There's a lot of different ways to do this. So we talked to Joe Mallon, who is the chief investment officer from Helios, who helps build the portfolios and the strategies. Interesting conversation. I think the most interesting part of this conversation was the bond talk, which is kind of boring to some people. Never thought we'd say that. I find it interesting.

So anyway, here is our talk with Joe Mallon from Helios. We're joined today by Joe Mallon. Joe is a chief investment officer at Helios. Joe, welcome to the show. Hey, thanks for having me. We had Chris, the CEO and founder on a little while ago, but for those that might have missed it or who are unfamiliar with Helios, why don't you just give a quick introduction on who you are and who you serve? Perfect. We are effectively, as the industry would call us, an outsource CIO or a model strategist. I think we're kind of a hybrid of the two. So we've coined a term called insource CIO where we assist independent financial advisors in building quantitative-based models

for their practice. We support them with research and compliance and serve that role of a CIO for a flat cost as opposed to a traditional basis point structure. Who are the clients are typically doing these? All RIAs. What were you working with here? Well, more than half RAs. We started our firm and cut our teeth in the AmeriPrize channel, which is not one you'd think of as having an outsource CIO solution, but because we're just a research provider, we are able to work with those teams and they do the execution and leverage our content and research for their decision-making process. So we serve a research role within their investment committee, but ultimately because they have discretion and can act on it, they do the trades. So it's a little

bit different structure than most firms work, and that way we can work with any independent advisory firm, they just need to be able to have trading discretion. I saw a stat. I'm probably misrepresented the exact number, but it's directionally accurate, where model portfolios have grown at 18% compounded over the last decade or whatever the exact number is. I think part of the reason is because advisors want to give financial advice that are more planning focused and they want to let somebody else who is more of an expert on the investment side lead those efforts. Is that the sort of thing that you have seen? And are those the advisors that you're primarily working with? A hundred percent. We're trying to capture that trend and do it a little bit

different. I think you hit on it. There's the benefit to outsourcing, having someone else do the investment work for you. Because if we're honest, an advisor best served, spending their times, maintaining their client relationships, doing the financial planning side of the business. If you're a smaller advisor firm, you can't afford to hire a high-quality investment team. So I think outsourcing it gives you that high-quality story, but it also gives you the operational advantage. We've come across so many teams where you look at their book of business and they have 1,000 different funds across their clients and they just made it up every time someone came on board. And it creates a really messy disaster operationally to try to trade those accounts.

I think model portfolios creates that efficiency and creates a uniformist story across your client. mind-based. You obviously have a number of different advisors who might have different ways of looking at the world or different philosophies. How do you work on implementing your models in your way of doing things into these advisors who may look at the world differently? I love that question because I think that's where we're unique. We don't have a set of models. We started as a firm six and a half years ago having just that. We built these quant-based models that incorporated trend following, economic data, yada, yada, yada, these academic principles that a lot of people are utilizing within models. We looked at that and said, wait, these models aren't really one-size-fits-all. Everybody's a

little bit unique. So we decoupled all of our signals, and we now call them elements. And we work with an advisor through our technology to cater a series of models. portfolios for them. So we effectively build a recipe. We say, how many risk levels do you want? Do you want to be purely strategic and have no tactical movement in your account? Fine. We'll help you build that. We'll work within your compliance guidelines and we'll help you do the research on funds. Or we can go really tactical. We can do a combination. Maybe you want to be tactical in your qualified accounts and non-tactical in your non-qualified accounts. We can build that too. So it's funny, we spend so much time working with

advisors on the front end. And one of the first things they say to us is, you guys are the expert, just give us your model. But every single time, the more you talk to them, they do have a preference. They do have a style. They do have a theme. And we want to hone in on that and give them a perfect set of models that make sense for their clients and their practice. I think the term outsource CIO is one that most advisors are familiar with. What is the deal with the insourced? What does that mean to you all? Maybe I'd ask you, what do you guys think of an outsource CIO. What role does that play with an advisor? To me, I think of advisors that are handing off more or less all of the decision making. This is the model. This is the execution and we follow it

for better or force. I think the benefits to an advisor are very clear there. Many of those firms have a slew of CFAs on staff. They do research on mutual funds. They check your box as an advisor from a compliance standpoint. You've done your research. You've done your documentation. They do some market research and they operate your models for you. We actually immerse ourselves inside the practice and take a seat in their investment committee. Everything we build is custom cater to their practice and under their brand. With many of our advisors, their end clients have no idea who Helios is. We just give them the tools and we consult with them to build a custom set of models that they then take control of brand and market to their clients. And we work

with them on the story and the ongoing content and research and material that complements the models that they've built. The clients don't even need to know that you exist, really. Correct. We have no legal or contractual relationship with the end client at all. You're not set up as an RIA? We are not in RAA, but we have an RAA that oversees us, myself and Chris and Jason on our team, are registered.

And that's totally just a belt and suspenders approach to say, hey, our clients are registered RAs, we can't. We actually tried to register as an RA, but because we don't have any assets, we don't qualify. So we said, can we just work as a DBA of a large RAA and have them provide us our compliance oversight and review our marketing material? So that's what we do. You're not executing any of the trades. You are simply saying, here is the model. I assume you want the advisors to follow it, but it's up to them to push the buttons. 100%. And we help them assign different tickers to the model. And at the end of the day, when we make a change, it kicks out and notifies to them. Here's our recommendation for a model. When they go execute it, if they execute it, and what they execute it with is really up to them. How much feedback do you get from advisors in a year like this where Michael and I talk to a number of advisors? We have our own clients that we work with. And I think if you would have told me before the year started or even the last 18 months, inflation is going to be.

going to be 9%. Stock's going to be down double digits. Bonds are going to be down double digits. I would have assumed people would be freaking out a little bit more. How is the general mood among the advisors that you work with in this environment? I think we had a couple of things going for us. We had COVID, which was a complete shit show. I don't know if I can say that, but you can. That works. Great. And that really scarred people. I think they're like, wow, life can get real scary real quick and maybe my investments aren't the most important thing. but we have this massive rally afterwards, and double-digit returns in 2020 and 2021 really helped to soften the blow that was 2022. We had that one thing going for us, and I think the other part

is everything's down, whether you're in bonds or equities, your safe investments are down, that there's not a lot of blame to put on folks like us that are supposed to pick the best thing. and that made this year, I think, a little more palatable to end clients and definitely to advisors. They realize how hard of a market this has been and trying to pick the right positions to be in has been very difficult. There's nothing you could point to to say, hey, you idiot, why didn't you put me in this? Everything really is having a tough year unless you pick some really niche strategy and

you're all in energy stocks or something. Exactly. And I think alternatives are gaining a lot of steam. I think blood's in the water for alternative wholesalers right now, as it should be. But we're very cautious with those, as people should be, on a lot of research and just, hey, what are your expectations here? What's your hope? If your hope is to maybe earn a 1, 2% return and a down bond in stock market, great.

But if things rally from here, you're not going to be happy with being in that alternative. So it's a tough time to think about going to the things that have won this year because the winners are still negative, except energy. How granular can you get? So, in other words, what if an advisor said to you, I want an all energy sleeve. I don't want XLA, but I want stocks that fit various criteria of whatever the case may be. Like, is that something that you offer?

How granular do you get? Yeah, there's really, let's call it three or four components to building a model with us. The first is, when I say the word tactical, how much do you want to fluctuate on your risk tolerance, how much equity versus fixed income, how much of that ratio are you willing to navigate with that. And how do you want to do it? Sorry to break in. I'm curious, if you could break it down like back of the envelope, how many of your advisors do use tactical? I'm always curious to that because some people are just dyed in the wool. No, we're buying hold or we don't do that. How many of your advisors use tactical? I would say two thirds, three quarters, definitely use

something very tactical. Interesting. That's more than I would have thought. But there's a blend and it doesn't make sense from a tax perspective to be very tactical and non-qualified account. That Question is an interesting one because we've actually seen it. I think our hook and people, why people are really attracted to us in the first place is being that OCIO that's willing to do tactical. But the more we talk to them, it tends to shift more strategic or lean more strategic. Once we really press them, we do a lot of, hey, it's great to backtest something that has 4% outperformance. But let me show you what would have happened in this scenario when you underperformed by 15%. So they end up using, I don't know, a 10% or 20% sleeve, something like that in tactical?

Yeah, they build a model that's highly tactical and then can complement that in a client household with something more strategic or they can build a model that just has a range of 10% tacticalness to it and you kind of get the net effect in one model. Back to your question, Michael, about the stock sleeve. Not only do we determine how tactical the risk is, we have multiple ways of thinking of asset allocation within equities. So do you want to be just buying a hold within equity? Or do you want to sector time? Do you want a country time? Do you want a growth value U.S. international? And then it comes down to the positions that you fulfill that way. So the model is going to tell you what

asset classes down with. And then the question comes, what ticker do you want to put into it? Do you want to be just a passive low-cost beta ETF? Or do you want to be ESG? You can take that same model that you built, create a carbon copy of it, make it ESG by using ESG funds. So there's all of these layers that we have to go through to get to what that end model portfolio looks like. What if somebody wants to use individual stocks instead of ETFs, can you accommodate for that as well? That's that fourth layer where we have a tool that applies 16 different factors to the stock universe. You can adjust your number of tickers you're seeking, what factors you want to apply, and yes, they can use individual stocks. I will say, though, that our bread and butter is more

the model portfolio. We do that stock research as a complementary service to the advisors we work with, but someone looking for heavy stock research that's not as interested in the model-based product that we have typically aren't target clients for us. How much of a differentiated view do you all have on the market? Is there like a house view? Or, Or is this really driven by what advisors are telling you? We have a house view. We go back on a rules-based quantitative process. We have this arsenal of tactical ways of thinking.

And given the world right now, what do we think is most opportunistic? So is it having trend, is it having a contrarian point of view and buying the dip here in low asset prices? Is it better to just diversify amongst equities, or do you want a strategy that's more active in terms of timing of duration and credit risk? So we have all of these weapons, and we try not to take a firm stance or view on where the market's going. I think if we looked at certain asset classes where maybe you need to make some more decisions

than you would have in the past, but we're rules-based the same way, but that doesn't mean you don't have to make any decisions. You just have to make a lot of the hard decisions up front. So I'm interested in how you look at something like fixed income these days, where in the past, it seems like you could have put your money in anything in fixed income. You would have been fine. You could put it in treasuries, high yield, whatever. Rates were falling. Yield started out at a high level. And it didn't really matter what you invested. And most people diversified amongst their equities. Now I think people are realizing, well, I'm dealing with more volatility in fixed income. I have to figure out what's going to the yield curve. I have to think about inflation protection. What's my yield going to be? All these different things. How do you think about that asset class, which is I think something advisors haven't had to think very hard about until recent years. I had mentioned we have varying ways to think about fixed income. It's our most practical way to think about fixed income. This is exactly where we're positioned in why.

We're incredibly short duration and we have been for over a year. We have no high yield or we tilt towards treasury exposure and we're about as conservatives as we can be. We look at inflationary data to say if inflation is high, we want to be short duration. We look at the move of the yield curve, and the yield curve's actually telling us right now to be long duration because we feel it's a mean reverting process. We look at credit spreads to determine if we should be in high yield or not. Trend following in high yield credit spreads is a very successful long-term technique.

Then we look at other, quote-unquote, satellite asset classes, and we apply a trend-following rule there as well. Michael and I were talking about the yield curve stuff today, and it's interesting because you're being tempted to do two things. On the one hand, shorter term yields are higher. So you want to just say, why would I take volatility in this asset class? If inflation stays high and if rates continue to move and stay volatile, why wouldn't I just clip this four or four and a half percent coupon in ultra short term bonds? On the other hand, well, what if we have a recession coming and that means rates are going to fall and the longer end of the curve is going to do much better and give you a bigger

bang for your buck. So I feel like that's a tough call for people right now because if I go on the short end, I'm going to miss out on this potential bond rally if the economy does slow down or fall apart. But it's so safe and tempting and comfortable, why wouldn't I just clip those coupons? Yeah, you could. I think the traditional way of thinking is look at your time horizon. You take more risk or less risk. But that paradigm right now with the inverted yield curve turns that whole thing on its head. But what you're abandoning is exactly like you mentioned, the duration. Duration can be your friend. It was not your friend this year. to a magnitude of multiple that we've ever seen.

But if you're really looking for that long-term diversification relationship, you can get that yield, you can get the return by going super short term, but you're giving up the lack of correlation or counter correlation benefits of fixed income in a diversified portfolio. If we go back to academics

of building a diversified portfolio. So I agree. I think depending on the client, if they don't care and they're looking for four to six percent return meet their financial plan, go short duration. Awesome. This is a world in which you can actually get that again. You couldn't get that two years ago. You were screwed. We think, especially for folks in retirement, if you manage this route well, we're in a really good spot now for retired

folks. There's the inflation thing, but we can't control that. We can't control inflation. What we can control is what we invest in. And if inflation falls, we can get that 4%, 4 and a half percent guaranteed. We're looking good from a financial planning perspective. And I guess the good news is, whichever route you choose, if rates fall and you are starting with a good yield, you have better options in fixed income you've had in a very long time. It's been a painful year, and I think people have a hard time overlooking that, but that's in the past. That's sunk cost. But now going forward, I think you have two decent paths if the economy slows and rates fall that I think you can do well in both,

probably. We talk about this a lot. Just the slope of your return has changed in fixed income. And as painful as it was, go back a year ago and say, you're going to get 1% for the next five years. What's your total return going to be? 5%ish. Now, do that same math, but you're starting with a 15% loss, but you're going to get 4.5% for the remaining four years. Where are you going to end up? A little over 5%. The math doesn't really change in the fixed income, aside from credit defaults and all those things,

but typical treasury math is very simple. And what you've lost here in return, in mark to market return, you're being compensated going forward. And unless you're going to die within three or four years, we're probably in a better position today than we were a year ago. Unless short-term rates come way back down. Unless short-term rates come way back down. But you've ridden this wave again and you'll have a lot of excess return over a short

period of time. They'll be back to clipping 1%. But where we're sit today is a better path. There's no doubt about that. But how do you think about certainly this changes the equation for the stock market, which we've seen all year. If you can now get a 4.8% risk-free nominal return in treasuries over the next 12 months, you're going to think much differently about buying Spotify or whatever, high growth names. So now that we've seen a lot of destruction in the growth-oriented names, are they a potential

attractive opportunity? Or do you think the equation still matters where it's like, well, yeah, they're down 90%, but I could just get 4.8 in one year. Like, why would I even bother with that junk? I mean, it's a valid question, but I think the opportunity set and the valuations have come down again to make them attractive. And I think if we do have a recovery, if rates start to fall, I think you could have a nice pop in equity. So I get the thought process behind it long term, but at the end of the day, adding that

risk should really benefit you if we have an equity market rebound. Ben and I were talking about that this morning. It's kind of wild that over the last year, yeah, it's been a rocky ride, but the S&P is down less than 10% over the last 12 months. Yeah, that was down, what, a couple percent? Then, yeah, it hasn't been that bad if you've been on the bad. If you've been diversified and didn't go on in tech, it's not as bad. It seems like it could have been worse, even though at one point we got bad and maybe

it's bad again. I don't know. You mentioned about the alternative thing, how you're tentative to go into that space. what kinds of strategies are advisors looking for in the alternative world? They're looking for the golden goose and they're just not going to find it. And that's the problem. They can go in and identify an alternative fund that have had great returns. But when you look per strategy in alternatives, so if I say global macro, the returns all over the map.

The variation in risk and returns are huge. It's really that way with every asset class and alternatives except for maybe real estate. real estate equity market neutral where you kind of stuff like neutral beta those are the ones where i think the return variances aren't that great so it's more a question of picking the right fund which now is a whole other question in itself not do i own alternatives but which fund do i own and that becomes a little tricky so it's more about expectation setting finding a fund that hopefully doesn't have any surprises for you and creates that diversified positive return in your portfolio But trying to time something that's done well over the past 12 months is a very silly idea.

How do you think about liquidity or lack thereof in these names? There was big reports this week out of Blackstone and B-Reed, which is now seeing more redemptions than inflows, and they're having to gate that. How do you think about that and how should advisors think about that? That's part of the dangers. And you're talking not so much about liquid funds, but rather LP-type structures, I assume. I know firsthand, early in my career, I worked for a firm that launched a private equity fund to funds. And that was one of the challenges with that, because when they draw down capital,

it's a commitment you make, not funding the whole nut up front. When you have these redemptions, you don't have that liquidity within these private investments that you make. So they have a certain level of percentage of liquidity that they can provide. And when you run into these stress test scenarios, that liquidity is just not there. That's why we just caution people with limited partnership tech structures. Make sure you size them the right way. Make sure you don't invest too much of the overall household in any individual fund or strategy. But overall, I don't think that's our bread and butter. I was telling Michael the other day, I came from the institutional world, the endowment foundation world, and we had a trend following strategy. And in 2008, it was the only

strategy that was up. And this manager was just licking their chops thinking, we're going to raise so much money. But the problem is everything else was down. And so they used them as an ATM. And so if you have a private fund that's illiquid and you say, we're actually up on the year, guess what, people who need money are going to take money from you. You mentioned the asset liability mismatch of short duration, needing cash flows and long duration assets. They don't think through those operational challenges, I think for people that, oh, if everything else is down, I'm going to take from this because that's my one gainer. I'm rebalancing, and that just throws everything off. The type of clientele and the pension endowment world, I think,

are smart like that. They have to rebalance too. They have specific mandates that they have to meet an asset allocation, so they have to pull from the winners. That kind of happens all the time. I think the advisor world's a little different, though. They tend to run more towards the hot assets. That problem is more high net worth, ultra high net worth, institutional, people really investing in LPs versus your less than high net worth. My secret of the institutional world was they run to this stuff just as much as everyone else. They just say they're sophisticated and gets them by.

Can you talk about what does your average advisor look like in terms of, I don't know, number of households, assets, and how does the relationship begin? It really does vary, but I'll say our biggest bang for our buck is that the advisor that wants to grow for maybe 50, 100 million to 500 million or a billion. We do have multi-billion dollar teams we work with. We tend to be a component of their investment committee or a series of models that they execute on. But if you think of all of the checklist of items we provide, it's best served on a service. smaller team, maybe one to five advisors. They are having to find a solution for investments. They don't have one. They've contemplated either investing in a team to do it or they may have

a team that's retiring or the benefits of outsourcing just don't really help them compete. So here's a softball to follow on that. Why do advisors use Helios instead of a model portfolio from one of the big asset managers that they could find anywhere? They can retain their brand. they can be a fiduciary to their clients and not be beholden to one asset manager and their tickers. They can provide a level of tacticalness and behavior to their models that doesn't just do the buy and old strategy that everyone else on the street is doing. And then we provide all of the ancillary content. So we're doing monthly and weekly calls with our clients on what's going on in the world. We provide them decks and presentations that they're free to leverage.

and all of this is conversant within their model portfolios that lie under their brand. So it's the same question of, why would I use BlackRock? I mean, if I was a $10 million, I would. It makes sense. It's free and it helps you get your business off the ground. But I think you reach a level where you want to be competitive. And we provide people with that edge and story. We have a lot of advisors who listen to the show.

Anything else that we miss that you'd want them to know? Not really. I think from a product standpoint, we're excited with what we're doing because we've converted our concept into technology. And we now have a website where advisors can come in and dial up and down the different elements within a model and understand the results, the benefits, the stress test of what it means to introduce something like volatility targeting into a model portfolio and access our research on individual mutual funds and stocks and ETFs all via a website and then they can literally download those model portfolios and upload them right into their trading software. and we're working on integrations to just say, hey, push my model to my trading partner. Tell us the website to send people, if they want to learn more. Heliosdriven.com.

Perfect. Joe, this is great. Really appreciate the time. Thank you. Yeah, thanks, guys. Thanks again to Joe. If you're an advisor, want to learn more, go to heliosdriven.com. Send us an email, Animal Spiritsbod.

com, and we'll see you next time. Thank you.