As the chief gatekeeper for Charles Schwab, Michael Iachini needs to keep a cool head.
Luckily, methodical thought is second nature to this strategy games enthusiast, who currently counts Agricola, a board game focused on agricultural resource management, as his favorite.
‘Board games are a very strategic hobby and very math-based … and that tends to be me. I tend to think very methodically and quantitatively, and that translates well to the work I do,’ he says.
Iachini is head of manager research at broker-dealer Charles Schwab and is responsible for its Select lists, which play a key role in both its $1.3 trillion advisor business and $1.5 trillion direct investor division.
It’s a giant task, which involves not only analysing every single fund on the Morningstar database, but putting together best-buy lists of exchange-traded funds (ETFs).
Iachini knows all too well how a lack of rigor in investment selection can backfire. Asked about his worst investment decision, he thinks back to before his time in investment. ‘Not knowing enough about finance before I began my career to keep my mother out of high-cost mutual funds that her advisor recommended,’ he says.
Board games are a very strategic hobby and very math-based and that tends to be me. I tend to think very methodically and quantitatively, and that translates well to the work I do
Let me list the ways
Iachini’s flagship selection is the Mutual Fund OneSource Select List, comprising 170 funds. Along with the smaller Income Mutual Fund Select List, featuring 38 funds, the list is marketed at Charles Schwab’s army of direct investors, as is the 68-strong ETF Select List.
The lists are also relied upon by Charles Schwab’s advisor division, alongside a further five mutual fund lists and a separately managed account list.
Unsurprisingly, Iachini has a large team to draw upon in putting together these lists, with 37 analysts working for him, including 35 working alongside him in Schwab’s Denver offices and two in the broker-dealer’s San Francisco headquarters.
Between them, they examine every mutual fund available, provided it has a three-year track record, handing it a rating based on six factors: alpha, expenses, fund size, fund family resources, cash inflow and active share.
Out of this comes a score, running from a top score of one to 100 for the lowest-ranking fund. The top 35% are eligible for the Select lists, with the top 10% given an ‘A’ rating and the rest ‘B.’
‘It’s multi-factor, it’s forward looking and it’s not one size fits all,’ says Iachini. ‘Our goal is, if we give a fund an “A” rating, it means that its percentage likelihood in outperforming its peers is better than 50%. Funds that we give “A” ratings to should do better than their peers and funds that we give an “F” rating should do worse than their peers.’
Currently, 70% of ‘A’ funds have outperformed their peers.
‘We would love for it to be 100%, of course, because it does mean that 30% of the time we give a fund an “A” rating it actually underperforms, so that’s kind of a bummer,’ he says. ‘But it’s far better than a coin flip or just chasing performance.’
Examining alpha is a crucial part of the process, as it helps to show which managers have added value through their stock selection, rather than just rewarding those who have ridden the beta wave in rising markets.
‘Alpha is security selection skill, because that’s going to work no matter what the market does,’ Iachini says. ‘If the market goes down and high beta is not going to help you, then picking good stocks relative to whatever universe you’re picking in is always a good thing.’
This focus also allows for the team to take account of a manager’s style and won’t lead them to cut a manager solely because their approach is out of fashion.
We want to make sure they are people we have confidence in and aren’t just lucky with a great track record
‘If you are tilted toward value and value is out of favor and you’ve underperformed, well, we kind of expect you to underperform, and we’re not going to penalize you for that,’ Iachini says.
It’s a quantitative model that is evolving. One of the recent changes was to introduce a methodology for preferred stock funds, which led them to adding to the Cohen & Steers Preferred Securities and Income, and Destra Flaherty & Crumrine Preferred and Income funds to the Mutual Fund OneSource Select List.
‘Both funds rated very well in our quantitative rating system, and my fixed income analyst at the time, Raani Varma, found both funds to be well managed with no serious concerns quantitatively,’ Iachini says.
The human factor
But it’s not all about numbers. When a fund gets a high rating, the team is then tasked with understanding the strategy and processes behind it through fund interviews.
Iachini’s team of three mutual fund analysts is broken up by asset class: Christine Knezevic handles international equity, Beth Zawde examines domestic stock funds and Annie Haberman takes care of fixed income. These three conduct phone interviews in order to assess management expertise.
‘We want to make sure they are people we have confidence in and aren’t just lucky with a great track record. We want to make sure they have actual skill.’
Changes to that management tend to be the reason why a fund is dropped from one of the Select lists. ‘It tends to happen if they have manager changes,’ Iachini says. ‘If a manager leaves the fund and they were very key to the strategy, the new team might be alright, but we would like to see them prove themselves first.
‘Most managers come to see me, they come to our office and they understand our process where they’ve had a call with me, so they are not taken back by that. They understand the quantitative piece of it.’
But a change at the top will not always lead to a fund being cut. ‘If it turns out that they were important but they left a good process and team behind, then we might still be comfortable keeping the fund on our list,’ says Iachini.
Funds are added or cut from the list every quarter. Iachini, his boss, Jim Peterson, and Brett Bennett, the managing director of managed account research, have a two-hour committee meeting to discuss recommendations.
Iachini's key players
Counting the cost
Costs are a more straightforward issue to examine, and can mean various share classes of the same fund can attract different ratings depending on their charges.
For Schwab’s ETF research, fees are of paramount importance. Emily Doak is Iachini’s senior ETF analyst and will examine charges, looking at the annual expense ratio, coupled with the bid-ask spread and the impact of commissions.
Tracking performance relative to the index is also considered alongside size, with only ETFs with more than $20 million of assets allowed on the ETF Select List, and liquidity.
That enables the team to examine a sector where headline costs have been under heavy pressure, but sometimes do not give the whole picture.
‘We have seen that whole ETF fee pressure taking shape, which is great for investors. I love seeing those cost come down,’ Iachini says. ‘Part of our analysis for the ETF piece is bid-ask spread. If the liquidity on one ETF looks a little better that can sometimes impact which one makes it.’
Recent additions to the ETF Select List include the Vanguard Consumer Discretionary, Guggenheim S&P 500 Equal Weight Consumer Staples, Guggenheim Solar and SPDR Wells Fargo Preferred Stock ETFs.
‘Vanguard, State Street and Guggenheim are all very closely priced on the Schwab platform. Vanguard has a low expense ratio but they’re not commission free, Guggenheim is commission free – all three of them are pretty close,’ Iachini says.
Environmental, social and governance (ESG) funds could also soon be making their way onto the Select lists. Iachini and his team started analysing both ESG mutual funds and ETFs this month, in response to investor demand.
‘This is kind of a toe-dip for Schwab,’ he says. ‘We hear that there are some investors that might like some more information on socially conscious investing, or ESG, so we’ll provide something and see how it goes over with clients and Schwab representatives.’
It’s a typically prudent approach from Iachini, who counts as his best investment decision sticking to his low-cost, diversified investment approach during the financial crisis.
It’s perhaps why he likes Agricola, a game that rewards those who can build the most balanced and prosperous farm, and penalizes those who focus too heavily on a single aspect of the game. It’s a strategy he’s proved adept at in his investment career.