Edelman Financial Engines, a registered investment advisor with $288 billion in AUM, prides itself on its cool-headed, scientific approach to investment decisions. The philosophy underpinning Financial Engines, a tech-focused retirement plan advisor co-founded 35 years ago by Dr. William F. Sharpe, a Nobel prize winner in economics, was always based on the idea that markets are generally efficient. In 2018, the firm, then with $169 billion in AUM, merged with Edelman Financial Services, an RIA with $21.7 billion in AUM founded by Ric Edelman that catered to the mass affluent market. That deal emphasized the combined firm’s core competency of offering advice to everyday Americans looking to build their nest egg.
Edelman Financial Engines does not believe in trying to time the markets or jumping on the latest “magic” solutions for growing wealth, according to Neil Gilfedder, executive vice president of investment management and chief investment officer at the firm. However, in working with its clients to achieve their retirement goals, the RIA wants to make sure it continues to incorporate newer products if they feature the right return-to-risk balance. It also wants to accommodate clients’ personal preferences—such as commitment to ESG causes, for example.
WealthManagement.com recently spoke with Gilfedder about how Edelman Financial Engines approaches investment decisions and works with clients to make them understand the process.
This Q&A has been edited for length, style and clarity.
WealthManagement.com: What’s in your model portfolio?
Neil Gilfedder: We really don’t think so much about models. The general principles underlying these are common. First thing is with our client base, it’s very much planning first. It’s understanding the client situation, and that leads to the selection of the portfolio they are put into. We have an intellectual heritage going back 30-plus years. Part of that is our company was co-founded by Bill Sharpe, a Nobel prize winner in economics. We believe markets are generally efficient. One of the things that we don’t do, and we deliberately don’t do it, is make bets on timing the market. We will stick to our allocations, redo the allocations using updated market information, but we are not going to make opportunistic moves in or out of sectors or countries or durations. That’s by design.
Secondly, we don’t manufacture investment products. This allows us to look at the entire universe of instruments that we can put our clients into. We don’t have relationships with investment management companies either. We have a machinery, a quantitative model that examines roughly 38,000 different funds, ETFs, stocks, bonds and so on. The first thing we do in terms of picking the instruments we look at is to run quantitative analysis, and then we will supplement that with qualitative analysis. That’s talking to managers, understanding strategies and so on.
We are not a purely passive shop. We do have active exposure, but we are very careful about it. We think active management is hard, and we favor low-cost, repeatable processes in active management.
WM: What about asset classes?
NG: We want to get people into a portfolio that involves the most potential return for the risk they are taking. And that involves exposure to domestic, international, large caps, small caps, emerging, public markets, bonds of different durations and different types. We are assisted in constructing those using Optimizer that we built in-house along with our model. We will build the allocations using Optimizer and go forward that way.
WM: Would you be able to give a breakdown by percentage of what asset classes you’re invested in?
NG: Let’s say the typical client has a 65% equity portfolio. These numbers vary, and people will get different ones depending on certain factors. But let me give you the ranges here. They would get large cap U.S. stocks at roughly 30%, U.S. smaller caps at roughly 12%, international about 17%, bonds at about 30%, and then, we’ve got themes that we’ve tested. We’ve got about 9% in other themes, which are real estate and exponential technology. And the rest is in cash and short-term bonds.
We minimize the actual cash allocation. We deliberately hold short-term bonds, but cash we hold really only in order to administer the portfolio, to be able to do trading and so on. Over time, we reduce the amount of cash, and cash basically works to help the portfolio work. It’s not in itself a strategic allocation.
WM: How often do you update your allocations?
NH: We have a model that we use to monitor what’s going on in the market in terms of risk and return. We don’t reallocate every model every month. We don’t think it’s warranted to do that. But we do review them.
On the other hand, we do review every single person’s portfolio every day to see if they drifted from the allocations we’ve assigned them. And again, most days, we don’t touch those models, but we do check them.
Our clients, almost all of them are saving toward retirement goals. That’s a longer horizon, and our process is deliberately not to jump in response to markets. We will periodically do re-allocation. Last week and the week before, when markets were very wobbly, what we did was review if everyone was close to their desired allocations, but we deliberately did not jump and move the allocation itself. We just don’t think it’s useful for getting people toward their goals.
WM: In your opinion, what are the main factors that differentiate your portfolio from other firms?
NH: First off, we come from a quantitative background as a firm. We are very rigorous in how we put these allocations together.
The second thing I would say is we are very deliberate in our approach. We don’t do these tactical re-allocations. It’s not because we are unable to; we choose not to consciously because all the evidence shows it’s extremely hard to time these correctly.
One thing in our models is, while we do not time markets, we do have what we call themes and an accommodation of themes and preferences. That is something people get with us that we think is valuable. Let me give a couple of examples. The first one is we do a quantitative construction of ESG models that we profoundly oppose. It’s not that we think there’s a return to be gotten from ESG investing. It’s a preference, and we build portfolios that, given the preference, will maximize expected return for the risk. We allow people to implement preferences in a responsible way. The second is digital assets. We’ve had quite a lot of people come to us and ask, “I am interested in digital assets. What do I do?” And our approach is to work with them to discuss in the context of a retirement account what that could look like. We’ve released allocations that people could opt into after discussions with their planner that has a small—1% or 2% allocation—using spot crypto ETFs. What we do then, if the crypto allocation rises, we harvest it and diversify it.
This is very much something we do in partnership with our clients, so that they are able to invest in this sector they are interested in. And our job is to ensure that it falls into a responsible part of their retirement plan. That’s something that we’ve done fairly recently. We are kind of leading the way in being able to do that for clients.
We also have a Digital Asset Portfolio. This is a separate portfolio we can put people in for a limited part of their investment. What this does is not just hold spot crypto, it holds what we call crypto-adjacent holdings—things like investment in blockchain companies. We use a selection of ETFs. We did a lot of research on what the offerings are and how they relate to each other, examination of correlations and so on. What we’ve seen is you get exposure, but you get a lot less volatility. There actually is diversification in holding different parts of the crypto universe. And that’s been of interest to some of our clients, especially those with higher balances.
Another thing we have is looking into our client base, we have concentrations in markets in the Bay Area and the DC area. We have people come in who worked at companies and, through their time there, built up a lot of stock in the company. The reason they come to us is they have a sense that they should diversify. But they are also attached to the stock. We’ve built in our internal systems a process where we can show them an analysis of a mixture of tax and risk impacts of managing their portfolios. This has been successful with clients.
What we have done is work with them on transition plans to bring the stock down, but also doing a full optimization around it. So not just saying, for example, that a technology stock of some sort is simply large cap, which is a common approach. What we do is an actual optimization around it. And what we’ve been able to do for these clients is move them toward a diversified portfolio in a tax-aware way over time. That kind of stuff you have to do on a completely customized basis for clients.
WM: While we are on the subject, we saw the launch of Ethereum ETFs a few weeks ago. Is that something that’s now part of the Digital Asset Portfolio?
NH: At the moment, the Bitcoin one is, but we are actively talking to all the major ETF managers. We are tracking how correlated Ethereum and Bitcoin are. We are certainly on top of this. We haven’t moved into it yet; we want to see how these things behave. And we also want to understand the managers’ different approaches because there is a lot of technicality behind the scenes in running a crypto ETF.
Just to underline, this is something that clients would talk to a planner about wanting to do. Almost all of our clients have no exposure to this. This is only something that comes with the client initiating a conversation with a planner.
WM: But you said you have relationships with asset managers.
NH: We know them, but there is no financial relationship. We know the people in them because we want their expertise.
WM: Can you talk about what types of investment vehicles you are using?
NH: For our core clients, it’s mutual funds and ETFs. However, we are very interested in the private asset space. The quality of investments you are able to get for the more mass market investor has improved a lot over the last few years. There are some interesting vehicles available. What we already have gone out with is a private debt offering to our clients. We don’t take a financial supermarket approach to this. We did a lot of manager meetings and a lot of curation and research on the deal. So we have a private debt offering.
Just this week, we are rolling out a pilot of a private equity offering. Again, we did not rush into this. We had a research department look into this; we interviewed a lot of managers. The reason we think these are good is that a lot of the market is now not listed, it’s private. We think there is a return to be gotten there. We need our clients to understand that they are sacrificing liquidity.
We may look at private real estate. We are sort of kicking back around to see if we think there are good instruments and if it fits with the profile of our clients.
We are in the investigative stage of doing custom indexing. Again, we are in heavy discussions with managers, quantitative analysis, and understanding what they can do for our clients’ use cases. So, we are deep in the analysis of that. We aren’t committing to do it yet, but we think it’s an intriguing area.
WM: You mentioned a private debt offering and a private equity offering. What kind of vehicles are these in?
NH: The private debt is an interval fund instrument, so it’s a wrapper where you put in money as you wish, and there are monthly withdrawals. Obviously, if there is an unlikely case that there’s a rush for the exits, it’s gated.
This August, we will also be piloting a private equity portfolio for our clients. That will be a leading tender offer fund.
WM: What are your top stock picks right now?
NH: We don’t think concentrated stock picking adds a lot. That’s not the same thing as saying we don’t think active management can add things, but concentrated stock picks are not part of how we think about investing. It tends to add more risk than you get compensated for in rewards.
We do get questions from clients about this. We get clients asking about blockchain, for example. For most clients, just pointing out to them that they are holding companies in funds that both directly do this stuff and will benefit if this takes off. So, you hold bank stocks. If blockchain really becomes a game-changer in transactions in terms of efficiency and security, then the banks are going to be using it, and bank stocks will benefit from it. So, we try to orient clients away from wanting to hold individual stocks just because we think it’s not the best for them to achieve their retirement goals. It’s going to add volatility and potentially hurt them quite a lot.
WM: On the analysis that you do, you obviously take macro-economic factors into consideration. How are you accounting for the current environment, where we’ve had this rise in interest rates for quite a time and now it looks pretty likely that we’ll have a cut soon?
NH: If we go back to our intellectual legacy and modern financial theory, a lot of this is priced in. We do get questions—interest rates are going up, should you have really allocated in advance of that? The answer is no. The reason is this stuff gets priced in almost immediately. In terms of what happened in 2022, the expectations of the market, the expectations of forecasters were simply wrong. Inflation surprised everyone, surprised the consensus anyway. So, we did not reallocate portfolios there, and at that point, the bond allocations had negative returns. But we were holding to that, and at this point, we are starting to see, with rates starting to go down, bond funds are starting to do better. Our view is you hold onto your core allocations through cycles, and you understand when you are exposed to an asset class there is potential long-term return, but that comes with potential risk.
While we are aware of the macroeconomic environment, we are not going to move portfolios into that. It’s just exceptionally hard to time it. There have been so many false storms over the past year or so about “interest rates are about to go down.” We stuck to our allocations.
WM: Do a lot of people get nervous and come to you when these shifts in the market happen and ask to change allocations, especially since you are working with their retirement portfolios?
NH: Yes. It's something I find particularly interesting. It’s so important to give them context for what’s going on. We in investment management make sure that our planners have the information to talk about this to clients. That’s a mixture of our long-term evergreen materials, but we also want to make sure that people know what’s going on. If you listen to the news every day, it’s very hard to form a complete picture of what that actually means for you, and that instills fear. What we try to do is to give people long-term context and say “Yes, this can look scary right now, but remember if you take a long-term view, the diversified approach works over time.” It’s a matter of reassurance, and our planners are very skilled in this. That’s an essential part of the service we help our clients with.
WM: You mentioned you have some international assets. Can you talk about where those are and what your thinking is behind those allocations?
NH: International is one of those asset classes that goes through long periods of either underperformance or overperformance. We’ve had a long run with the U.S. outperforming, but we are still in common with a lot of institutional investors, keeping [international] exposure. We think there is return to be had from investing internationally.
We think of it in three regions. The first is Europe; we have an exposure there. A separate one is Asia Pacific developed markets. And the smallest allocation is to emerging markets. Emerging markets are quite volatile, but over the long term, they can help the portfolio. When we do portfolio construction, we combine those in a way that takes into account all their correlations. We invest in developed markets quite heavily, and a smaller amount into emerging markets.
WM: You mentioned that you worked with people who had investing preferences for ESG. How often are people concerned about that, and how many clients want that service?
NH: Honestly, it’s a small part of our book of business, but it’s something we want to be able to offer. We talk with them about that preference, understand their commitment to it and then come up with a portfolio for them that makes sure they are doing it in a way that helps their retirement goals the most.
WM: Can you give a concrete example of how this would look? Let’s say a client came to a planner, and they cared about ESG. What happens at that point?
NH: The way that plays out is the client would say to a planner, “I am saving for retirement, but I am interested in the environment, or another part of ESG.”
What the planner’s first thing to say is “Look, there are different ways to act on your environmental preferences. You can be more effective donating to charities or supporting political campaigns. There are things that could potentially have more impact on than holding to what amounts to very small share of these companies’ holdings.” So you want to make sure that people actually want to go and invest, or if this is a preference they can act on it in another way.
Let’s say they say, “No, I want to hold this.” The way we think about this is always in terms of choices and consequences. We have the ESG allocations in the system that we use, and the planner would be able to show the person, “This is what it looks like. Here are the potential risk implications. Here’s the historical record of what ESG has done. It can move similarly to a traditional portfolio, but it does differ. And by not being fully diversified, there’s the potential that over time you are going to miss out on some return just because you are not as well diversified.” And it’s about making sure the client is along for that journey and they understand it. One of the things that our planners do really well is making sure that people know their retirement is 20, 30, however many years away. It’s going to be bumpy. In a way, ESG changes that dynamic slightly, and are you really comfortable with that? We want the client to make a well-informed decision at the end of the day.
