Acquisitions are on the mind of Jeff Montgomery, who took over the helm of AFAM Capital at the height of the financial crisis in 2008. The following year, the firm acquired Innealta Capital to diversify its product lines, client and asset base.

AFAM's chief executive officer spoke with Money Management Executive recently about what he's currently looking for when he hunts for deals and how the growth of the exchange-traded fund market has fueled his expansion plans.

 

Tell us about AFAM Capital's background and why you decided to join the firm.

 

I had previously run the securities units for a publicly traded financial services firm and I was looking to take over as asset manager because I believed in the role that institutional asset managers play for financial advisors-so I bought a portion of the company and took over its leadership. I wanted to take my experience with financial planners and move it into the money management arena. When I took over the company, it was a manager that specialized in dividends, originally called Al Frank. I wanted to transform the company and get into additional solutions. So we are now called AFAM Capital, and we acquired Innealta Capital as one of our divisions in 2009. We bought Innealta Capital to diversify our product lines.

 

What was your experience like during the height of the financial crisis?

 

Everyone was shocked by the correlation across all asset classes. Emerging markets and developed markets all went down alongside real estate. Our Innealta (Innealta is the native Irish word for "smart") division seized on a lot of tactical opportunities. Innealta had positive performance in 2008. Virtually no money managers were able to do that. That's where we made our name. The broader market was down around 35% on the S&P. We were positive. That's when advisors started taking note. And more broadly, 2008 reminded advisors and clients that risk management is a key part of any financial plan.

 

What makes a good fit for you as far as management and products? Are you looking to make a buy this year or next?

 

What makes a good fit: number one is culture. It's critical that you have the same values and outlook on the business as the company you're buying and that the key people share similar views. We will also buy other companies that have financial products that are not correlated to what AFAM currently does. And yes, we are looking for additional acquisitions for this year and next.

 

You currently advise more than $5 billion in assets. What have been the top three drivers of your growth?

 

The main driver of our growth has been a focus on managing risk for clients. Also, as noted by Morningstar, "tactical" investment strategies are key to today's investing landscape-because tactical strategies adapt to market risk, and have become very popular with financial advisors and retail clients.

The rise of exchange-traded funds has really fueled our growth. Going back just over 20 years, ETFs didn't exist. The growth rate on average for money going into the managed ETF space has been more than 40% in the last three years, a growth rate which is unheard of in the industry. This is a new class of managers-ETF managers. There were less than 100 such managers five years ago.

Our motto at Innealta Capital is "winning by not losing." Advisors like us because they want a portion of their client portfolio to be in something with limited risk. Modern portfolio theory just isn't modern anymore-people have learned that investors should still have a long-term view, but they also need to be adaptive. They must adapt to risk in the market. Managers like us use quantitative models to measure risk, and then methodically manage that risk for clients while seeking opportunities to gain when tactical conditions are favorable.

 

What trends have you been seeing in the ETF and mutual fund space and what's your future outlook?

 

The trends for ETFs are clear: They are beginning to dominate the landscape and are efficient and cost effective trading tools for professionals and individual investors. We are seeing more and more money flow into ETFs. The reason for the slow embrace: the previous dominance of the mutual fund industry. We're not predicting the demise of the mutual fund industry. But very simply, the mutual fund industry has had a 50 year-plus head start.

Mutual funds have endured a tough stretch since the crash of 2008. They remained in net outflow through Q1, 2013. This is perhaps the worst period (now ending) in mutual fund history. They remain a very large part of the investing landscape, and are still a good tool. We have both mutual fund, and ETF portfolios. Things are starting to stabilize for mutual funds in general, although bond funds are having a very tough quarter as interest rates rise. I think mutual fund providers are getting more creative and sophisticated about their products.

One of the most exciting developments in years in the mutual fund industry is the emergence of mutual funds of ETFs (mutual funds that own ETFs). We will launch more in the future as this is a growing area.

 

What most concerns you about current regulation/proposed changes?

 

Getting a good and fair definition of fiduciary responsibility for financial planners. It's important to understand the level of fiduciary duty that planners have. Financial planners hire us and we manage money for clients, so the fiduciary discussion has been the biggest discussion the last few years. We always react by working with regulators, not against them. We keep scouting for changing rules constantly. Both the SEC and FINRA have done a good job reaching out to members of the industry for dialogue. I just think the more dialogue, the better.

 

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