Michael Batnick is managing partner at Ritholtz Wealth Management, an RIA that serves over 1,000 high net worth families and oversees nearly $3 billion in assets. The firm is perhaps best known for its media presence, from CEO Josh Brown’s regular CNBC schedule to chairman and CIO Barry Ritholtz’s podcast with Bloomberg, “Masters in Business.

This interview isn’t about any of that, however. As the first interview we’re publishing after inventing the title “Financial Futurist” (You can read what we mean by that here), I wanted to dig into how the very nature of being an RIA is changing, and how the business of financial advice has actually become a hotbed of “what’s next” thinking.  

I’ve always believed that innovation-wise, Michael is Ritholtz’s secret sauce, the driver that keeps the firm not just in the news but on the leading edge of the financial advice business. Recently, he and I sat down to dig deep into Ritholtz’s signature strategies, including its tactical portfolio, its new crypto SMA, its forays into direct indexing, and more. A lightly edited version of our conversation follows below.

Michael and the team from Ritholtz Wealth Management will be joining us in Miami Beach for Exchange: An ETF Experience. You can watch a live taping of his popular show with Ben Carlson, “Animal Spirits,” at 4 PM on April 13th. Register to attend the event here.

Dave Nadig, ETF Trends & ETF Database: You spend a lot of time thinking about the business of being an RIA. Do you have a client “sweet spot?” Are there clients who are too big or too small? Or do you think about your clients in terms of complexity, not scale?

Michael Batnick, managing partner, Ritholtz Wealth Management: So I’ll say that people are people. And people are people whether that person has $500,000 or $500 million. They all have the same worries, right? Their worries change slightly: “Are my grandkids going to be okay?” is a different worry than, “Can I fund my retirement?” But in terms of managing relationships and dealing with general anxiety, people are people.

Some people with $100 million own index funds and don’t have a million trusts set up. Their financial life is actually uncomplicated, despite their nine-figure bank account. Then some people have $2 million and have overcomplicated things. Our job is to clean it up.

Nadig: I’d imagine the latter is probably more common because it seems like our world rewards complexity at every corner. There’s always something new and shiny; there’s always a better way to try to do something. Does that make working with new clients harder than you might expect?

Batnick: I’m not a financial planner. I have a financial planner. But, obviously, I give financial advice: I talk to clients, I manage portfolios. And I often talk to clients about “position sizing” an investment; based on the markets and the potential investment, I might say [they should allocate] 2-3%, maybe 4%, if they’re super excited, and so on. Still, ideally, I want the advisor to own every single step of the relationship.

There are moments, though. With the market volatility in March 2020, I was on the phone five hours a day! I’m thrilled to do that, but I really want the advisor to feel empowered to own the entire relationship.

Nadig: When those moments of volatility arise, how do you handle them?

Batnick: Most of the time, it’s easy to say “long-term, long-term, long-term.” But the long term is a series of short terms. And if you cannot survive those short terms, then the long term is completely meaningless. It’s lip service.

Nadig: Speaking of short-term, you actually do run a tactical portfolio at Ritholtz; you just don’t make a big deal about it.

Batnick: Well, yes and no. In a perfect world, nobody would use it. But the world’s not perfect, and buying and holding is supremely difficult. But I never want to say to a client, “Don’t worry, the market always comes back,” because that’s not realistic. We are humans. We worry. I worry. Worry exists.

Yes, the market has historically always come back, but while you wait there can be an enormous amount of pain and uncertainty. I don’t want to use history as a guide for that sort of thing.

But we do not sell tactical as an alpha strategy. If anything, you’re right, it’s a distraction because if it does beat the market, we’ve got serious problems. One of the problematic things about a lot of the alternative-bear-market-whatever strategies is that they can’t survive a bull market. If you can’t survive a bull market, you don’t have a viable product.

Nadig: So what have you actually put in place and how you decide whether to put a client in it?

Batnick: A lot of this strategy was built on the work that Meb Faber (Cambria Investments) did with moving averages. At first, we were resistant to the fact that that was viable, so we did the backtests ourselves to validate it. [When we did,] the first thing Josh Brown (Ritholtz Wealth Management CEO) said was, “Why doesn’t everyone use this?” And my answer was, “It’s not bullsh*tty enough.”

Nadig: It’s too simple?

Batnick: It’s too simple. So we said, “All right, let’s just see if we can make it a little bit better. Let’s really data-mine the hell out of this: What if inflation was here? Or interest rates were there? If you put tolerance bands around the moving average?” Just all sorts of things to torture the data. We beat it up.

While we did do some tweaking, generally speaking, it was [already] pretty d*mn good. We went back to 1926, and in the end, of the 30 of the worst months ever in the markets, if you used this simple strategy, you would’ve avoided two out of every three. [That’s] a 2/3 win rate.

But it also means you’ll be invested in one out of three of every worst market environments imaginable! So I’ve been very careful to communicate that is an equity portfolio; it will shift to bonds at a certain point, but only after some damage has been done. At some point, the market will roll over, we will sell, it will bounce, we will get back in, and it will roll over again. I know for a fact that will happen someday. And when it does, it’s going to suck.

When I used to talk to advisors and clients about this, I threw cold water on it. I would show them the monthly returns, and we would highlight in big red letters April and May of 2000, back-to-back months, where it fell 15% in April and 8% in May. We are very careful to make sure that expectations are realistic.

Then again, we’re advisors. We’re not hedge fund managers. I’m not trying to pitch this to an endowment. We don’t need to have the highest Sharpe ratio in the world, but guess what? This thing was built to survive in a bull market, and it survived.

Nadig: How many of your clients are in the tactical sleeve in some capacity?

Batnick: Most are. We have a few guardrails. In a perfect world, we’d allocate roughly 20%. But the most important thing is that they get their tax-deferred assets in here. What this [portfolio] is designed to do is to distract you from the fact that the rest of your money’s getting bludgeoned, right? So you can sleep at night and not mess around with the most important piece.

Nadig: As in: At least you did something, right?

Batnick: Exactly. Getting out is very easy. It’s ridiculously simple to hit a button on a bad day and say, “Whoa, now I feel better.” But getting back in is basically impossible unless you have rules. If you get out at 10 and you tell yourself you’re going to get in at a lower price — which, you’re not going to, but let’s say you tell yourself that, “I’m back in at eight,” — you’re not going to. You’ll wait until seven. Or worse, you’ll sell at 10, the market goes to 11, and you think it’s rigged.

So we have rules to get out. And more importantly, we have rules to get back in.

Nadig: You’ve also been getting into crypto with an SMA offering, enabled by the crypto-for-advisors group OnRamp and based on an index run by WisdomTree. Is this another case of just putting something in place to manage client expectations? Or is there a real belief here?

Batnick: I think that there is still a lot of unease and uncertainty about what crypto assets are and what they’ll become. We’re still very, very early, and allocations are going to be small.

Here’s how we’re thinking about it. On the one hand, there are very few assets today that have the potential to increase exponentially, that could give you a 5X return in 10 years. But with that potential comes — I don’t want to say “the potential for complete ruin,” [but you could be] down 20% in a day, or 40% in six days. For most clients, that’s ruin because they’ve never experienced anything like that.

So we have to balance those two things: This could be a lot bigger in the future, and therefore we want you to have enough [allocated] so that if we’re right, it matters. But we can’t give you so much that you say, “Guys, what did you just do to me? I can’t believe I listened to you.”

Nadig: At the same time, you had to design an access vehicle because the ETF industry and SEC can’t figure it out yet. It’s a little ridiculous that you had to manufacture opportunities that they couldn’t find on their own.

Batnick: I feel good about this because crypto is genuinely overwhelming. I’ve traded some crypto in all the craziness and made a little bit of money, but then I knocked myself in the head. I’m like, “What am I even doing? This isn’t what I do.”

So I decided, going forward, that every dollar I invest in crypto, I want to be in an index. When something has the potential to go up this much, I don’t think you need to pick the winners. I don’t want negative alpha. I want broad-based exposure. So working with Jeremy Schwartz and his team at WisdomTree was just such a blessing because they have the expertise.

The index covers 67% of the crypto universe, so it won’t be a beta of 1, to say, bitcoin. It’ll be a beta of more than 1 because the index has some of the smaller coins in there. So it’ll likely move more than bitcoin does.

Nadig: Is [this portfolio] another kind of behavioral hack, like the tactical portfolio? As in, you’re not trying to get everybody into crypto. You’re just trying to have a “do-no-harm” vehicle for clients interested in the exposure.

Batnick: We have had clients as for crypto, and our answer used to be, “If you want to buy bitcoin, open up an account at Coinbase, Gemini, wherever.” But it was never a tidal wave or even close to it. It was drips here and there. Nobody asked [us], “When are you going to build a crypto product?”

But I know that clients turn to our advisors for solutions. So to have one for them that we believe in when they do ask, it’s a great feeling.

Nadig: Another innovation you were early on with would be your early adoption of O’Shaughnessy Asset Management’s [now owned by Franklin Templeton] Canvas custom indexing platform. I’m a big fan of how they bring customized index and quant-based portfolios to investors through advisors. How did that come about?

Batnick: Back in 2018, I had lunch with Jim O’Shaughnessy and (OSAM Chairman and CIO) Patrick. I was very skeptical. I said, “Well, what about this? And X, Y, and Z? I just don’t see it.” Patrick just said, “Well, we’re building something. I’d like to show it to you when it’s ready.”

When we had a demo later on, I was immediately blown away. I came back and told everyone, “The next billion dollars we raise is going to be on this platform.” There were challenges internally. As I remember it, there was an advisor or two that said, “Wow, this is awesome.” But many advisors were like, “What is this? Everything’s going fine. Why would a client want to hold 400 securities? How is this better than ETF?” And on and on, down the line.

Nadig: To be fair, each of those is a legit question.

Batnick: 100%. I never said, “Just shut up and trust me,” because I don’t work that way. I had to convince them. The way I convinced them was by leaning on the product. The product was so strong. The technology was so strong. We had such a front seat at the table to shape it. We were talking to their product team and their account reps for months before we brought this to our clients. I was the first money on the platform, and to say that it’s gone better than expected is an understatement. It’s changed our business.

Nadig: What’s been the biggest hook? Taxes? ESG? Is it single-stock solutions for people who have over-exposure because of corporates?

Batnick: We have many clients who have gotten very wealthy working at a company for their entire life, so they have an enormous amount of single security risk. In the past, we put it in a separate account and would come up with a way to scale out of it over time. Then maybe we’d try to take some losses in the funds to offset. But it was clunky. Now we can build a portfolio around this asset.

Nadig: You weren’t doing, like, sector tweaking? “Oh, this guy’s a tech executive; we’re going to go light on tech?”

Batnick: No. Not even that, because we can’t really buy the S&P-minus-tech, right? For an advisor to manage positions like that, it becomes unmanageable.

Nadig: You’re not going to start shorting XLK.

Batnick: Right. It becomes completely unmanageable. So to be able to build a portfolio around this key holding — [shares of] Google, Apple, Microsoft, whatever — is enormous. Then to be able to show them a glide path with what the tax ramifications will be, to be able to enter their state and federal tax levels and target the dollar amount of taxes they’re willing to pay in a given year. It’s huge. And it’s dynamic. A client can say, “Oh, hey, I just sold this building, so let’s really dial it up,” and we can tweak the tax-loss harvesting. It’s powerful.

But we don’t invest differently. What we did was we tell Canvas, “Love the technology. I don’t want advice on how to manage our portfolios. Here are our portfolios, recreate this on Canvas.” We had to trust that that was going to be the case, and it has been.

Nadig: Tell me how you’re interacting with the pieces of the portfolio that Canvas can’t necessarily handle, like emerging market stocks or corporate bonds or whatever. How is that experience from the customer’s perspective?

Batnick: No difference. For example, one of the things not on the platform right now is TIPS. We have [them] in our core portfolio. So we’re using ETFs, and we’re totally fine with that for our fixed income exposure.

Nadig: So single exposures: big deal. Taxes: big deal.

Batnick: In March 2020, I think we harvested $6-7 million of losses in single stocks. To be able to do that is beyond phenomenal, right? To do that on the ETF and mutual fund model portfolio side in real time, when the markets are moving as quickly as they did, when you’re one button away from seriously blowing something up… To be able to outsource that is huge.

Nadig: I’ve heard a lot of folks talk about the ESG side of direct indexing. Was that a big deal for you, too?

Batnick: It’s there for people that feel strongly about it. I love that it’s their ESG — the client’s. It’s not BlackRock’s or anyones. It’s what they believe. It’s their portfolio.

But what we don’t do is let clients do is say, “Hey, I don’t like banks now,” or “I don’t like X now.” If you feel strongly on your values, we’ve got a solution for investing. But we’re not trading your values.

Nadig: In the past few years, you’ve made some big investments in direct indexing, running a tactical sleeve, and crypto. What’s next? What problems are you trying to solve for your clients next?

Batnick: You have to play the field as it lies. This is the world we live in, and people want income. That’s been hard. We’ve been looking for something, and we’re uncomfortable with all of the alternative ways to generate income.

One of the things I’m bullish on are alternative sources of credit. Platforms are coming to advisors trying to solve this, and I think they will do phenomenally well on the business side. And I think private market investing for advisors is going to be the thing for 2022, 2023.

I think the risk profile is different because the illiquid nature of these things adds another dimension. I am bullish on illiquidity. Not because I think investors are dumb, but just with the private investments that I’ve made myself, I feel a lot better about these things not being marked, even if I’m hacking my own brain. And I’m willing to pay for that. So easier access to pools of private securities.

But mostly, I just feel so lucky to be in a dynamic business with endless opportunities and challenges to work on. I’m so happy to have great partners and colleagues and the best clients in the world.

For more news, information, and strategy, visit ETF Trends.