Shelley Bergman: Portrait of an ETF Strategist

September 29, 2014 at 08:00 PM

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Search far and wide, but you're unlikely to find many financial advisors as shrewd about investing with exchange-traded funds as Shelley Bergman, managing director-senior portfolio manager of The Bergman Group at Morgan Stanley on Fifth Avenue in New York City.

Bergman was smart enough to start using ETFs more than eight years ago, when the flexible investment vehicle was in its infancy. Today, the ETF market boasts a whopping $2 trillion in assets and is the fastest growing product on the market. Bergman and his clients are, increasingly, reaping the rewards.

He is a 30-year-plus advisor and ranked No. 5 on Barron's Top 100 Advisors list for 2014. A Chairman's Club member, Bergman is the sole advisor of his eight-person team, managing about $3.5 billion in assets for high-net-worth and ultra-high-net-worth clients.

With a deep knowledge of the ETF universe, Bergman, 52, a Queens, New York, native, knows just how to make the most of these funds' potential for boosted performance and better client outcomes.

So expert is Bergman that he's the go-to guy for many other investment professionals, including hedge fund managers who hire him to manage their personal accounts.

Indeed, one client who relies on his judgment is head of ETFs at a competing brokerage firm.

"He knows ETFs like the back of his hand, but he can't pull the trigger at the right time to invest in them. There are a lot of people like that. After about 35 years in the business, I have no problem going into the burning building to try to find out whether we can make some money. It's something I was born with," says the tall, bespectacled Bergman, who was with Bear Stearns for 20 years before joining Morgan Stanley in January 2008.

Over two decades, the investments he has managed have far exceeded the major indexes, he says. In the last five years, the FA has stressed ETF investing and is, more and more, moving clients into these funds.

"History suggests that the vast majority of active managers underperform their benchmark. The benefits of ETFs are very, very strong," Bergman says. "ETFs are game-changing: They give you the ability to mix stocks and bonds, and to make a sector investment in a particular area and get a very exposed piece of an asset allocation focused in that area."

In the advisor's overall book, 20–25% of clients are in ETFs, with at least $250 million invested in the funds daily. That amount can rise to as much as $400 million to $500 million depending on Bergman's special short-term calls, which are typically contrarian.

For his balanced accounts, about $200 million to $250 million is allocated to ETFs, which are managed with a proprietary, broad-based ETF-only strategy; closed-end funds are used occasionally. For his other platform, the advisor manages $250 million in ETFs and $500 million in individual stocks and bonds. Another $2.5–3 billion is in mostly fixed income.

Active Attitude

Bergman doesn't buy ETFs only to put them on set-and-forget automatic pilot. In fact, that's one of the worst ways to use these funds, he says. Bergman actively manages them with the distinct investment strategy that he, along with his group's portfolio manager, Kurt Walters, has developed.

Using a core and satellite approach, it aims for broad diversification and increased risk-adjusted performance. The core (strategic) portion is for global diversification and may include, for example, large and small cap securities, short-term credit fixed income and commodities. The satellite (tactical) portion, to generate some alpha, is designed for targeted allocation of specific themes, sectors, asset classes and valuations; usually these are short-term plays.

Bergman offers clients three ETF portfolios based on risk tolerance: The aggressive one consists of 70% core and 30% satellite ETFs; the moderate and conservative portfolios are 74%–26% and 78%–22%, respectively.

Over the years, Bergman has made some controversial sector recommendations, for which ETFs were used as the investment vehicle. Indeed, he has a history of stepping into sectors when everyone else is getting out—and his results are impressive. A recent ETF home run was in natural gas.

"We just exited half the position up 50%," Bergman enthuses. "We thought the easy money had been made."

He suggests using ETFs to all his clients—including those not already in them—for investing in sectors or themes about which he feels strongly. That's where his tactical strategy comes in.

This year, Bergman made at least two against-the-grain calls. Emerging markets was one: When the sector was down 30–40% with record outflows in March and April, he took a large position in a Latin American ETF. By summer, it was up 20%.

Another triumph came earlier this year when the common wisdom on the Street was to flee investments in the developing BRICs countries—Brazil, Russia, India and China. Instead, contrarian Bergman used ETFs to get into the BRICs.

"Since April," he points out, "the best performing markets have been Brazil, Russia, India and China. In three months, China was up 20%."

ETFs are famed for being liquid, low cost, tax efficient and transparent. That they also can be traded at any time during the day is perhaps their most appealing feature.

"ETFs give you the ability to capitalize on an investment class, segment or theme more quickly than you could in the past," Bergman notes. The advantage of all-day trading "is where they really make a difference."

For instance, eight years ago, when a plane crashed into a New York City high-rise building, the event set off fears that it was another terrorist attack; and the market plunged.

Bergman saw opportunity. "I was able to go in [quickly] and buy a particular ETF that I wanted, which was down 3–5%. Within only 15 minutes, they confirmed that it was a private plane piloted by a Yankees pitcher," he recalls. "So there are dislocations from time to time that make being able to trade during the day a big advantage."

Bergman made that notable investment around the time he was developing his core/satellite ETF strategy. As a senior managing director at Bear Stearns, he was doing a deep dive into ETF research, testing funds in his personal accounts and determining which types of ETFs made the most sense and which to avoid.

"Properly investing with ETFs requires research, understanding and vigilance," the FA stresses. "If the captain of the ship doesn't know what they're doing, ETFs are worth nothing."

He pans advisors who, instead of focusing on long-term, broad-based allocation, trade ETFs too often simply because it's easy.

"Greed, fear and gambling seem to overtake a lot of investors," he says. "They're turning over the portfolio more often than they [ordinarily] would based on their thoughts about a particular sector."

Excessive Expansion

The savvy Bergman, who got himself Series 7-registered as a college senior cold-calling afternoons for an independent brokerage, is a sharp critic of the ever-expanding ETF world of products. There are now about 1,500 funds, as of July of this year.

"ETFs have come a long way; and because of that, if you're not educated, there's more and more confusion about what they are," says Bergman, who, after graduating from the State University of New York at Buffalo with a B.S. in business administration-concentration in finance, worked at Janney Montgomery Scott for three years before joining Bear Stearns. He believes firmly that there are far too many ETFs, far too many providers and not nearly enough transparency.

"Unless you can really dig down and get the providers in [to see you], for the most part you're bombarded with a smorgasbord where everything looks good until you taste it. They're trying to come out with an ETF for every single asset class. A lot of ETFs aren't good. A lot of ETFs overlap. Unless you read the fine print and meet with the managers, it's a black hole."

For instance, Bergman continues, "there are some ETFs that say they're covering financials; but when you look at them, they may be insurance stocks rather than banks. Some may have as much as 30% in, say, J.P. Morgan or Wells Fargo. So an ETF may not be broad-based. One that's labeled 'consumer discretionary' may have just a bunch of retailers when you thought you'd find a travel company or a leisure firm."

All in all, advisors must beware of "ETF traps," Berman warns. He cites a popular Japan ETF, iShares EWJ, that at one point had been touted widely in the financial press but, he says, wound up doing poorly.

"It wasn't hedged, and the currency moved against investors. Though they got the move right, they didn't realize they were going to get hurt on the currency. A competing ETF—from Wisdom Tree—that was getting no press, was hedged."

Bergman dismisses as "gimmicks" many entrants in what he considers to be a bloated, growing mountain of ETFs. Actively managed funds, especially, come under his attack.

"We don't believe in them," he says. "They seem like an oxymoron: The whole reason most people use ETFs is because they've realized that the traditional managers are underperforming their benchmarks."

Neither will Bergman buy inverse or leveraged ETFs. Designed to match the performance of the underlying indexes for a day, this type of fund is rebalanced so that it can again meet its objective of matching the performance of its underlying index for the next day, as Bergman Group portfolio manager Kurt Walters explains. Thus, "in a [volatile] sideways-moving market, whether you're levering up or levering down," he says, "you'll lose money."

Bergman stays clear of exchange-traded notes (ETNs) as well. These products are backed by the credit of the underlying brokerage firm. The risk, he says, is that "even though you can make a bet on the note in the right direction, if the note holder is a brokerage firm that should go under, like Lehman Brothers, you'll run into trouble."

What's on the horizon for ETFs? Bergman forecasts major provider consolidation. "The big will get bigger; the smaller ones will get absorbed or go out of business," he says.

But FAs will use ETFs to an even greater extent, Bergman predicts. "They've realized that over 10 or 20 years, most managers don't beat their indexes, and the fees for ETFs are dramatically lower."

This means that "advisors will need to become more educated and have some reasoning as to why an ETF will provide good coverage of a specific sector versus going out and having a manager do it for you. If I showed you the book of ETFs that Morgan Stanley, Goldman Sachs, UBS or any firm puts out, your head would spin."

Bergman helps educate clients about ETFs with an eight-page ETF brochure that he created. It features a summarized version of his portfolio strategy, highlighted by easy-to-understand pie charts and a clear explanation of benefits.

"To me, this is a very simple business," says Bergman, alluding to investing in general and ETFs in particular. "Over time, a broad-based portfolio will go only one way, and that's up. If you're not overweighted in any one asset class, you cannot lose in this game. We just went through the worst bear market but are now at an all-time high. If you had broad-based exposure through indexes, you hit the cover off the ball."

Sidebar-What Bergman Likes

For the first time in four years, contrarian investor Shelley Bergman, senior portfolio manager of The Bergman Group at Morgan Stanley, in New York City, has added financials to his ETF holdings.

"Most of the financial stocks have underperformed for the last two to three years, but we feel there's going to be a major consolidation among banks in this country," he says. "Though we don't see interest rates going up anytime soon, we believe that some of the larger banks will begin to lend again. The economy is improving. Net interest margins will come back eventually."

Another top Bergman pick is the commodity sector, in which he recently bumped up his ETF position.

"We like this sector at a time when everybody is telling you there's no inflation and you shouldn't own a lot of commodities. But we like them because they're too cheap. We love sugar and wheat and corn [etc.]. The world has to continue to eat, and these prices are at five-, 15-, 20-year lows."

But, the advisor emphasizes, investing in broad-based commodity funds is the route to success.

"Many commodity ETFs will be 30% top-heavy oil and gas. So if corn, wheat, gold, silver [and other commodities] go up, and gas and oil stay flat or go down, you'll lose money. But if you buy a broad-based ETF that has only 2% or 3% in each commodity, if oil and gas go down, you'll probably make a lot of money." —JWR

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