In 2019, a team of Morgan Stanley advisors in Texas broke away from the wirehouse to create Americana Partners, becoming the biggest single team to ever join the Dynasty Financial Partners network up to that point. At that time, Americana managed more than $6 billion in assets and included seven advisors across three Texas offices.
The firm has since grown to more than $7 billion in assets under management and added more talent from Morgan Stanley, including David Darst, the former chief investment strategist at the wirehouse, Alex Zengo, former executive director and bank officer responsible for Morgan Stanley’s operational risk coverage, and Phillip Knight, a former managing director and alternative investments director at Morgan Stanley, in 2023.
While the firm has built five model portfolios ranging from conservative to aggressive, Knight, managing director and partner at Americana, provides a look inside the RIA’s model most often used by clients—the balanced portfolio.
In the following conversation, Knight discusses the RIA’s allocation approach targeting exposures, how he uses alternatives to capture an illiquidity premium, and why he sees direct indexing as the biggest evolution of Americana’s practice.
The following has been edited for style, length and clarity.
WealthManagement.com: What’s in your model portfolio?
Phillip Knight: I have built portfolios the same way for about 15 years, and that is, we think of the world as exposures: rates, credit and equity. Rates being high-quality investment grade bonds where your risk is mostly interest rates; it’s duration. Credit is also bonds, but that’s where we think about risk premiums and risk of default, less about duration and the movement of interest rates because of their shorter maturities. And then equity is equity exposure.
The portfolio that clients use the most would be our balanced portfolio, which is 60% equity, 20% rates and 20% credit exposure.
Within the rates exposure, our goal is to match or outperform the Barclays Aggregate. All of our clients are U.S.-based investors, so it makes sense that that’s our benchmark for high-quality bond exposure. Within credit, we’re trying to outperform the Bank of America Merrill Lynch High Yield Index. And then within the equity sleeve, we're looking to outperform the MSCI ACWI Investable Market Index (IMI).
That’s our basic framework in that we’re just blending together these exposures, and we use capital market assumptions to tell us what those portfolios will return. And then when we do financial plans for clients, every plan is underwritten to a certain rate of return, and that tells us which portfolio the client might need to use.
Now, if we perceive an opportunity where we think we can improve upon those three benchmarks in any one of those buckets, we’ll do that. An example of that would be in late 2021, when rates were just at rock bottom levels, and the Fed was talking about coming off of zero. With the Barclays Agg having a forward return of 1.6% a year for 10 years, it just didn’t make any sense for us to own that. So we would pivot to short duration or own an equity market neutral fund. That served us well. We’ll make moves like that when we just feel like the exposure we would ordinarily have in the index is not ideal.
WM: What does the equity exposure look like? And what vehicles are you using?
PK: In the equity bucket, we’re using ETFs primarily but will occasionally use active managers where we think there’s enough asymmetry of information in that asset class that a manager could do some good. Emerging markets would be one of those. We have exposure to U.S. large, mid and small-cap stocks. We have an allocation to Europe, Japan and emerging markets. For large cap and small cap, we own just ETFs that target the index. For mid-cap, we own an active manager, the Principal MidCap Fund, and they’ve done a really good job for us over time. The mid-cap space is still, I think, pretty efficient, but if you have a manager that’s willing to lean into certain trends or to take out of consensus positions versus the index, I think you can do well there. In emerging markets, we use Virtus.
WM: Have you made any big investment allocation changes in the last six months to a year? If so, what changes?
PK: Today, if you were to look inside the rates segment of the portfolio, we own the Barclays Aggregate in the center, but we’ve overweighted investment-grade corporate as opposed to investment-grade government. We like that five to seven, seven to 10 investment grade corporate space, and we just buy an ETF to give us more exposure there. But we’ve also done a barbell where 20% of it is short duration, very high quality, almost kind of 90-day T-bills because we’re not completely convinced that we’ve seen the end of inflation.
On the other end of that, we’ve started buying some of these closed-end funds that own long-dated bond positions, like the BlackRock Municipal Income Quality Trust (BYM). It’s a portfolio of long-dated municipal bonds that currently have a yield of maturity of about 5.5% a year, tax-free. But because those funds incorporate leverage and right now, their cost of carrying that leverage exceeds the yield, it’s weighing on distributions. But if you can imagine a scenario where the yield curve kind of shifts lower and the forward end of the curve goes back down towards two, the distributions for funds like that look very attractive.
And the Fed may have to keep rates higher for longer, but then we’ve also taken 20% of that allocation and thrown it way out on the other end of the curve with some leverage so that if we find ourselves in a recession suddenly or a hard landing scenario, we’re going to be heavily rewarded owning that longer end of the curve.
Our big tactical position within equities is we’ve taken 35% of our equity sleeve—and a portion of that is a buffered ETF by First Trust—where we’re basically putting in place an equity collar, and that represents about 10%. The other 20% is an equity override strategy, the JP Morgan Premium Equity Income Fund. We don’t necessarily believe the Goldilocks or even Platinum-locks scenario moving forward that everything’s just going back to normal and valuations are going to drift higher, and there’s going to be a soft landing, and the Fed’s going to start cutting interest rates.
I think it’s going to be a little more choppy. And I think we could find ourselves in either a market where inflation surprises us to the upside and the Fed has to keep rates higher for longer. And the market has to reset expectations and valuations, or we may find ourselves in an environment where we just stagnate and move sideways. We’ve shifted in that direction of doing some covered call writing just to generate option premium, which I think will achieve 8% to 10% a year.
But we started, we initiated that position in January 2022, served us very well through 2022. And then in October 2023, when the market reached its most recent low, that was when we swapped about a third of that JEPI position for that buffered ETF where I was trying to give myself upside in the market because the covered calls really eliminate almost all of that.
WM: What’s your top contrarian pick at the moment?
PK: There’s a lot of opportunity to buy some of these closed-end funds that are thinly traded, where leverage is working against them. It’s creating big discounts to NAV. You can buy those today, and as long as the scenario doesn’t get worse, you’re probably picking the bottom. But if we suddenly find ourselves in a recessionary environment where the entire yield curve moves lower, and the front end goes back to one, you’re going to be glad you own some of those.
WM: Do you allocate to private investments and alternatives? If so, what segments do you like?
PK: We are prolific users of alternative investments, and that is probably the result of most of my career being post-financial crisis rates at zero. Equity always did well. I was always looking for alternatives to bonds. If our prescription is 25% in private markets, it’s going to be broken out with a similar allocation as our 60% equity, 20% rates and 20% credit portfolio. Of that 25%, 60% will be equity-like alternatives, 20% will be credit-like alternatives, and 20% will be rates complementary alternatives.
On the equity side, one fund we use is the Blackstone Private Equity Strategies Fund, BXPE, Blackstone’s new evergreen private equity vehicle for qualified purchasers. That’s been our focus the first half of this year is seeding that new portfolio that Blackstone is building.
It was really their response to what advisors were asking for all along. I’ve invested with Blackstone for 15 years, and to access all of their different verticals within their firm, you had to allocate to Blackstone Equity Partners IV and Blackstone Real Estate Equity Partners VI and Blackstone Real Estate Debt Partners XVII. So my clients would end up with all these Blackstone funds—some of them real estate, some of them private credits, some of them private equity. Years ago, they asked FAs, “How do we make it easier for you to do business with us?” And we said, “What’s killing us is constantly having to market all these different funds for you. It’s exhausting tracking all the K-1s and meeting all the capital calls. Create one fund that if I allocate to that fund, I get a piece of everything Blackstone’s doing. I get one consolidated K-1, and I want it to be evergreen. I want to put $500,000 in now and I want to put another million in next year when the client has another monetization event, and I want the ability to redeem from the fund. If I decide to call that capital back, I want to be able to request capital.”
In the private credit space, we’ve allocated to Ares’ new strategic income fund pretty heavily. This is a new kind of 2023 vintage private credit portfolio, mostly upper middle market. But we like that these are newly originated loans in a high-interest rate environment, and we trust Aries. We trust their underwriting skill, but we wanted to make sure we owned newly minted loans, not loans that were issued three or four years ago when these companies thought their rate was going to be 6% or 7%, and now it’s 12%. So we’ve been allocating there.
On the rate side, we use MacKay Shields’ municipal bond hedge fund. Think of a municipal bond mutual fund, but it’s wrapped in an LP instead of a 40 Act mutual fund. And what that does is, one, it tends to be larger pools of capital that have greater longevity. These investors aren’t constantly making redemptions. The fund also has liquidity every 35 or 40 days, so it allows the fund to be more invested. It allows the fund to take on leverage, and they can allocate to things like dislocated closed-end funds.
WM: What differentiates your portfolio?
PK: A lot of FAs think they need to be market geniuses or manager selection geniuses, and they’re always trying to outperform the benchmarks through security selection or shifting factor exposure. I don’t think that’s what our clients really pay us for. I think clients can do really well in retirement if you just match the index. What works well about our process is we don’t try to be the smartest market technicians. We gain outperformance versus the index for our clients in a very simple way, and it’s an illiquidity premium, so we just allocate to alts. I know if I allocate to a Blackstone private equity fund, I have a very good shot at making 12% to 15% a year. And I know I’m not going to get that out of ACWI.
So I can spend a lot of time trying to alter my factor exposure to the U.S. or international stock market, or I can try to work really hard at security selection and probably fail like most managers do. Or I can just buy an illiquidity premium.
WM: Do you use direct indexing? If so, why? Do you use an asset manager or tech provider for that?
PK: We are in the final stage of engaging with BlackRock to use their tool Aperio. We love the idea of direct indexing. If you look at the model I just described, that 60% equity is basically the ACWI at the end of the day. The thought that I could sit next to that, a direct index like Aperio, and have them do this hyper tax loss harvesting process that is improving my after-tax return. We’ve been doing the model portfolio alternative deal for 10 years, but the biggest evolution of our practice has been adding that direct indexing piece.
WM: How so?
PK: Imagine a scenario where we build a client’s financial plan, and it says that there’s supposed to be 70% equities and 30% bonds. What we would do is we would choose our balanced allocation, which might be 60% equities, 40% bonds, but then we would allocate 10% of their portfolio to Aperio and target the ACWI, which is basically it. So they’re still 70/30. We’re just taking a portion of that equity exposure, and giving it to Aperio; Aperio’s constructing the same index we’re trying to outperform in our model portfolios from an equity perspective, but now they’re owning the individual securities instead of owning the ETF, which means BlackRock can go in and do this hyper tax loss harvest function, which generates a treasure chest of capital losses, but make the other side of our portfolio more tax efficient when we do need to trade it.
WM: Do you expect to use direct indexing for other purposes, like concentrated equity positions or ESG?
PK: What we will most likely do for a number of our clients when we build this direct index is we will remove energy from the portfolio, not because our clients have a preference against it—the opposite. That’s the industry we work and live in.
That’s where they make their money, and the rest of their balance sheet lives in the oil and gas sector. So the thought that we can dial that exposure down so that we’re not duplicating it, our clients tend to appreciate. Most of our clients want diversification away from oil and gas. Now, not that energy is a big portion of any index, but I think if we did use it to express any type of ESG element, it would be dialing back the energy exposure so that we’re not duplicating that exposure for the clients that we serve here in the Permian Basin