USAA s Unique Strategy for the Advisor Market May 15, 2017 by Robert Huebscher Keith Sloane serves as head of third-party distribution for USAA Investments. Mr. Sloane previously served as a senior vice president at Hartford Investment Financial Services, LLC. Prior to joining The Hartford in 2007, Mr. Sloane served as director of product marketing and led the mutual fund business for Wachovia Securities in their investment products group. He joined Wachovia in 1995. Steve Fry is director of analyst relations for third-party distribution at USAA Investments. He focuses on home-office research analysts and intermediary-based consultants, as well as evaluates opportunities on USAA s recommended list. Prior to joining USAA in 2014, Mr. Fry served as executive director of the Analyst Relations Group at Janus Capital Group. From 1998 to 2004, he was vice president and senior product manager for Van Kampen Investments. Keith Sloane I spoke with Keith and Steve on April 27 at the Morningstar Investment Conference. What is your focus with regard to serving financial advisors? Keith: USAA started in the intermediary business roughly four years ago. We are the last of the big direct-sold shops. We ve been in the investment business since 1970 serving our members directly over the Steve Fry phone, over the computer and virtually. Over many, many years our customers would say, Hey, we love you guys for your insurance or banking, but my primary advisor is in Lexington Massachusetts or with Merrill Lynch. That demand grew over the years, so we decided to start making our funds available through intermediaries. I was hired to lead that effort about five years ago, and we were up and running about three years ago. The first step was to make ourselves available on all the major platforms, including the wires, the regionals, the independents and the large custodial platforms. We are now on virtually all of them. We are now available for advisors to access us. Essentially, we are a 47-year start up. How does your approach to fixed income differ from other institutions? Page 1, 2018 Advisor Perspectives, Inc. All rights reserved.
Steve: What we do differently is the fact that we have a yield-focused portfolio built bond-by-bond with fundamental research that provides investors exactly what they need. For a fixed-income investment, you are looking for yield. Our focus on yield, but more importantly, a keen eye towards tax efficiency, delivers for investors over the long haul a very, very competitive total return, but also income that they have been looking for. That s what we do best. We invest in the taxable and municipal markets. With distributors limiting fund-family offerings, how does this effect the asset manager sales process? Keith: We have gone from an environment of open architecture in the industry with maximum choice to a more controlled architecture. But not everywhere; the custodial platforms aren t necessarily doing that except at the margin, as they always have. You are seeing the effect of this more at the wires and maybe some of the other large independents. It hasn t affected us because we re relatively new to the platform and our best and most competitive solutions are up and running and they are not affected. Those who are affected are managers who have products that have been on the platform forever. They are in runoff, they are marginal in the quality, and that s who is affected. But what s not impacted are the more competitive, better priced, better performing investment solutions. We ll be fine and I think most managers will be fine. How has the DOL rule played into the selection of products that get onto these platforms? What other feedback have you been hearing from advisors regarding the DOL rule, specifically in regard to actively managed funds like yours? Keith: The DOL has slowed everything down in terms of progress. With adding new products, instead of being relatively straightforward it s, Okay, we re juggling an elephant right now, so it s going to take us longer to get approval process. That has clearly happened and will be a lingering effect. For us, fortunately, we were ahead of the game. For those asset managers who are adding on an abundant amount of new product, it s more challenging. From advisors, I have not heard a lot regarding the DOL. They are assessing it, but the impact in terms of the feedback from advisors has been pretty minimal. Our approach to distribution is largely the advisory business and in the fee-based programs where the fiduciary rule already exists. We re not in the loan business. USAA is not in the transaction or commission-based, brokerage intermediary channels. That is where the DOL is affecting the advisor community. The DOL rule is consistent with the approach that we ve had in getting into the intermediary business. Page 2, 2018 Advisor Perspectives, Inc. All rights reserved.
You don t see greater scrutiny being placed on actively managed funds, even on the advisor side? Keith: Great question. Is the active-passive dynamic being affected by DOL? It probably is, but as much as anything, market forces are driving the energy around passive investing. At USAA, about onethird of our equity assets are in passive products. We can supply those needs either way. We have a NASDAQ 100 fund and open-ended fund and it s actually very popular these days. It is benefiting from the tidal effect demand of passive strategies. Will that pendulum swing back to more active? We can compete in several areas and are competing really well in the active space, particularly in fixed income. What will be the next big disrupter in the industry? Keith: This is an industry that s oversupplied. There are 800 or 900 manufacturers that all do the same thing. How many industries have that many manufacturers doing the same thing? Not many. This is not really a disrupter, but more of an evolution of an industry that is oversupplied. It s also mature. What s the pace of consolidation of asset managers and suppliers? Is it through M&A? Is it through runoff? Is it through closing shops? Those are big questions that we ll soon see answered. But I sense that that the pace may accelerate because of DOL, the growth of passive and the increased demands from the home office culling the supply. You ve introduced an R6 share class across your funds to target retirement plans. What was the thinking behind that? Keith: USAA, being new to the intermediary space, realized that one of the areas that was a natural extension to the community we served was the retirement business. USAA does not have a retirement or 401(k) platform. The backdrop is that we serve the military community. There are 22 million veterans across America. When you take their spouses and their families it s over 60 million Americans. It s a large community. People don t realize how large the military community is, and it s all around America. About 11% of businesses are majority owned by veterans; that is over three million businesses and they employ millions of people. The military community and businesses run by the military community are larger than people see. This is a community that we serve with passion and, in many cases, they admire us and trust us as well. We ve never been able to serve their retirement assets in their 401(k)s. That was the thought. There is an opportunity for us to serve them in their 401(k) plans using an R6 share class. The price requirements of 401(k) platforms continue to decline; they re the lowest cost share class and we didn t have it. We felt like it was critical to put R6 shares in our best and most competitive investment solutions. Can you discuss the bond-by-bond approach that you use, where you are seeing opportunities Page 3, 2018 Advisor Perspectives, Inc. All rights reserved.
now in the bond market, and how that factors into your view toward interest rates? Steve: We are embracing what we see as a rising-rate environment as a positive sign because of the fact that what we want to deliver is yield to our investors. That is what they want with an eye toward providing income to a very, very income-starved investor. We believe that the very slow, methodical raise in rates will actually give us a broader opportunity set for uncovering great bonds. With our approach toward fundamental research, with over 20 research analysts uncovering the opportunities in our home office in San Antonio, we can come up with really good investment ideas. Most importantly, we hold them for the long term and provide investors with a very steady stream of income that we believe is what they are looking for in this environment. Which sectors of the bond market look attractive to you? Steve: In the municipal landscape there has been, since the election, some concern about where things were. There was a little bit of disruption, but most importantly the opportunity for municipal income investors is still very, very strong. There s still a lot being written about the pension fund situation across the country and how that ultimately will play out. Where and when do you see that impacting the municipal bond market? Steve: That s a difficult question, because it goes on a state-by-state basis, and each state has a uniquely different opportunity set. We ve got analysts broken up by geography, which is a very different approach to looking at municipal bond investing. For example, by having an analyst exclusively focusing on the California markets versus somebody focusing on the New York markets, we have the ability to say Okay, where are the pressure points and where are the things that could potentially be a challenge for us, and where do we want to align our investments for our investors? Keith: Because our managers pick bond-by-bond on a relative-value basis, and they seek to hold them as opposed to trade them, they avoid the concept of saying, Okay, geographically speaking, Illinois has pension issues as we know. They may say, Well look, they know it well enough that the individual bonds, say the hospital bonds, in Chicago represent a relatively good value even though there is a pension issue in the state. This geographic orientation, bond-by-bond purchasing and doing the credit research down to the individual security is a way to localize the individual opportunities. What is the focus of your team s efforts and what are your key plans for the future? Keith: We re focused in a couple areas. Number one is we are building awareness. We are new to this to work with advisors. We are still letting them know that we are available and that we have these capabilities. That s pretty broad, but essentially we are casting a wider net. We are also focusing on advisors who would have an inclination to listen to our story, and that would be those advisors who have served, or who may be USAA members, or may be embedded where there is a heavy military community. It would be a natural affinity because many of their clients are USAA Page 4, 2018 Advisor Perspectives, Inc. All rights reserved.
advocates as well. We are trying to target advisors who might be advocates for what we stand for. We seek those advisors who would be a match to our investment solutions: the fixed-income strategies or certain equity strategies. Certain firms might be more welcoming to partnering with us, so in certain cases we will target firms that we can deploy the previous three things I mentioned. But frankly, we are agnostic to the channel. We are targeting individual advisors just like we are targeting individual bonds to get our message out. Steve: From the research analyst perspective, our competitive advantage is having strategies going back decades with very sizable asset bases, and more importantly, with a very consistent methodical approach. That gives us a very unique insight to get to that next level of research, versus an idea that was cooked up a few months or a few years ago. We can come in saying we ve been doing this for decades, and we think that is a clear advantage. What do you struggle with the most when you try to understand what drives the advisory market? Keith: We want to understand the sales cycle and why the process to drive assets takes a long period of time. That s the challenge, because the complications of engaging advisors, centers-of-influence or decision-makers is much more challenging today than it s ever been. Just think about how people receive information. You need to break yourself through to create a relationship, because relationships still matter. People still want to do business with people they trust and admire and like. Breaking through to that is still key, and that is not always a short process. We still believe this is a business of people working with people, not just the transaction at the end of the day. Page 5, 2018 Advisor Perspectives, Inc. All rights reserved.