I’m glad I’m interviewing Paul Ricciardelli, rather than the other way round.
The Morgan Stanley gatekeeper’s famous attention to detail combined with his no-nonsense attitude mean managers hoping to be included in his portfolios must be prepared to face a thorough line of questioning.
‘We are more demanding of managers and expect them to clearly articulate their value proposition,’ he says. ‘Often it takes a lot of time to drill down to the answers we are looking for.’
But for managers who are able to convince him of their worth there are rich rewards: a much coveted spot in a Morgan Stanley model portfolio. There are few bigger prizes in the retail market.
Ricciardelli has been with Morgan Stanley since 2011, when he was recruited to head manager research. He came from rival wirehouse Merrill Lynch, where he had been for 11 years, latterly as head of equity due diligence.
For most of his tenure at Morgan Stanley he has been in a similar role, and until earlier this year Ricciardelli was co-head of global investment manager analysis (GIMA) alongside Alper Daglioglu. Now things are a little bit different.
While Ricciardelli still chairs the GIMA investment committee, which ultimately decides what managers get covered and recommended by that team, his day-to-day focus is now on portfolio construction rather than research.
Breaking it down
Earlier this year he was named head of a relatively new division called wealth advisory solutions, which houses a number of teams focused on building and managing portfolios (see chart), including the $20 billion firm discretionary unified managed account (UMA) models, which come in five main flavors:
- Passive-only models, made up of exchange-traded funds
- Fully-active models, made up of mutual funds
- Active and passive blends, made up of mutual funds and ETFs
- Hybrid models (with higher investment minimums), made up of mutual funds, ETFs and separately managed accounts
- Impact models, designed for clients interested in sustainable investing.
Each type of model has five risk profiles, from conservative up to aggressive, based on asset allocations set by the firm's global investment committee (GIC). Investors can then choose between strategic versions that rebalance once a year or tactical versions that trade more often. Then there are further variations such as those that use liquid alternatives and those that eschew them, as well as those that use municipal bonds and those that do not.
When asked how many models he oversees Ricciardelli smiles.
‘In a way it’s five, in a way it's 140,’ he says. ‘The count sounds like a lot, but the reality is that many are just versions of a base case.
‘Managing the models is very scalable. We could be two or three times the size of what we are quite easily.’
Take your pick
Across all their various models, Ricciardelli’s wealth advisory solutions team uses a total of 180 products. This breaks down as 96 mutual funds, 39 ETFs, 29 SMAs and 15 liquid alternatives.
The firm discretionary UMA program uses 50 strategies, including mutual funds, ETFs and SMAs.
All the products used by the group feature on GIMA’s Approved or Focus list. The former is made up of 70% of the 1,100 strategies covered by the team, while the smaller Focus list accounts for 30%, representing the unit’s high conviction picks.
Each model is made up of around 15 to 25 products. Those at the larger end of that scale tend to be active/passive products, where both types of strategy are used to cover a particular asset class.
The portfolio construction is, unsurprisingly, meticulous and leverages skills and research from other parts of Morgan Stanley, such as top-down guidance from the GIC and active/ passive weightings from a team managed by Ricciardelli’s boss Lisa Shalett, who is head of investment and portfolio solutions.
Once the team has a list of managers, it applies risk-budgeting techniques, profiling each manager from a risk perspective.
The weightings they are then given within a model are not equal but are sized according to a manager’s alpha and risk contribution to the portfolio.
Ricciardelli explains that the team looks for cross correlations of excess returns in an effort to see proper diversification across different sources of alpha. There is also a focus on style variation to ensure that portfolios are not biased to one particular factor.
Once an optimal blend has been built, the portfolios are then monitored on a daily basis so the team can identify where they might need to make changes.
‘The whole program utilizes the best components of the firm: top-down guidance, active/passive weights, GIMA’s manager research capabilities and finally our portfolio construction methodology,’ Ricciardelli says.
Making the cut
So how do managers make it onto GIMA’s Approved or Focus lists, and from there into one of the wealth advisory solutions portfolios?
There are many layers to the process, but one which is certainly unique to the firm is its Adverse Active Alpha manager screening and scoring process, which aims to identify strategies with characteristics that are known to lead to future outperformance.
‘The strength of this methodology is that it challenges a lot of current assumptions for screening and scoring that can often mislead investors,’ Ricciardelli says.
‘It looks for strategies with a high degree of active share, a proxy for the manager’s level of conviction. What is unique and proprietary to our approach is how we complement active share with something we call an adversity score, which effectively measures how well a strategy can fight into a headwind for active management.’
In simple terms, this means they handicap each year to determine how difficult an environment it is for active management within each asset class.
The better the manager performs in difficult environments, the more favorable their adversity score.
The team then normalizes these scores within each peer group and combines that with each strategy’s active share and re-ranks accordingly.
‘We’ve seen some very strong predictive power come out of this methodology and we use it as a way to generate ideas for further review, to help us decide our level of investment conviction, and as an input for manager selection inside the models,’ Ricciardelli explains.
‘It is just one component of our process. It complements our strategy review by providing an objective view of each investment universe and it really helps to avoid performance chasing. It is not a roundabout way to identify the top performers over the past five years. Anyone can do that.’
While such screens play a vital role, Ricciardelli also emphasizes the importance of meeting managers.
‘There really is value in face-to-face meetings and on-site due diligence,’ he says. ‘These visits tend to confirm or sometimes challenge our initial understanding, or give us some more things to think about.’
Two key qualities he likes to see in asset managers are a meaningful level of self-investment – although not 100%, as this can make them risk averse – and competitive charges. He argues that there is a provable relationship between these two elements and future performance.
He then wants to see that a manager’s portfolio construction adds value above and beyond their research and philosophy: in effect, that the manager-run strategy outperforms an unmanaged analyst portfolio.
Those who don’t rest on their laurels impress him.
‘We like to see managers who are “keeping score” internally and measuring the impact of the different components of their processes,’ Ricciardelli says.
We are impressed by those managers whose processes evolve through constant testing and re-testing; a commitment to maintaining the efficacy of their decision-making.’
While Ricciardelli’s team pick managers from GIMA’s list, they do their own due diligence too to ensure that the strategy is the right fit for the portfolio they have in mind.
This means quizzing managers is still very much on his agenda.
‘I do [still enjoy it],’ he says with a smile. ‘I think it’s important to stay connected to that. It’s critical to understand their plans in terms of new ideas or product development.’
And how do the managers feel about it? ‘I think managers do enjoy seeing us,’ he says.
‘It means that we are interested in their capabilities and there is a possibility that we may decide to move forward with them. They understand that it’s part of the process.’