Breaking down the role of the ETF strategist

Strategists face deeper scrutiny and new pressures to add value as advisers pump billions into managed-ETF portfolios

Apr 20, 2014 @ 12:01 am

By Trevor Hunnicutt

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(Lael Henderson)

Vernon C. Sumnicht saw the writing on the wall about a decade ago. The certified financial planner and money manager, who at the time charged fees of 1.5% annually, submitted a carefully worded proposal to consult a foundation on its investment portfolio. He said he lost the bid to a group of novices with social-science degrees, whose proposal — riddled with spelling errors — offered to provide the same service for 0.25%.

That moment took on a kind of mythic quality for Mr. Sumnicht, crystallizing a trend that he expects will continue to drive down the value many advisers will be able to extract from doing their own portfolio management.

In this new reality, he sought a way to deliver investment management broadly and cheaply — and so he became an ETF strategist.

Mr. Sumnicht founded outsourced investment manager iSectors. His team builds portfolios and trading strategies out of exchange-traded funds; the firm launched its first ETF-powered model portfolio in 2005.

Formerly marginalized ETF money managers seem to have come of age. Daniel Gamba, head of iShares Americas institutional business at BlackRock Inc., said they're "the sweet spot of our business."

And advisers seem to be recognizing the value of their strategies for clients: They've been pumping billions into them, with assets in managed-ETF portfolios increasing 40% last year to $96 billion, according to Morningstar Inc.

"The ETF providers are all scrambling over one another to get in front of their portfolio managers, because they're the fastest-growing and most visible clients," said Ben Johnson, an analyst for Morningstar.


But as the industry grows, strategist firms are facing deeper scrutiny, raising the heat on existing players and making it harder to get started in the business, according to several industry executives.

ETF strategists, who build and manage model portfolios, are getting pressed to add value. And their products' lower costs leave the managers little extra cash for marketing.

Yet alpha-seeking strategies take time and seed money to develop a track record and win the support of platform gatekeepers.

Those challenges contribute to the dominance of a few firms. The top three firms in the universe covered by Morningstar — F-Squared Investments Inc., Windhaven Investment Management Inc. and Good Harbor Financial — accounted for all of the top 11 fastest-growing strategies last year in terms of 12-month asset growth. A separate unit of Morningstar also has an ETF strategist business.

But the mushrooming industry includes more than 100 firms with 600 investment strategies of varying complexity and investment goals. Keeping up with the performance reporting and due diligence on money managers' offerings is a challenge for advisers.

"People don't truly understand what the ETF strategists are doing," said Rob Stein, chief executive of Astor Investment Management and a veteran in the space. "Any knucklehead thinks they can select eight ETFs and be the next guy, and on any given day, he might outperform me. He might have bought Brazil when it was hot, and wow, look at him go."

Some platforms that list ETF managed portfolios have started in the past year or two to raise scrutiny of the funds to a more stringent standard. And costs for these portfolios — which vary but include a management fee on top of custodial, platform and advisory fees — are facing downward pressure.

Tim Clift, chief investment strategist at Envestnet Asset Management Inc., a major platform for independent advisers, said the firm conducts on-site visits, works to effectively benchmark performance, and looks at firms' operations and trading capabilities.

"It's a whole new challenge to benchmark those strategies, so we've had to be creative," Mr. Clift said, noting that the marketplace can be challenging to navigate. "It is new and evolving, and it's not highly researched at this point."


Today Mr. Sumnicht's model portfolios include $139 million in assets, delivered for what he said are generally under 0.3% in management fees. As such, the thin margins leave little room for marketing or education for advisers, even though his models are listed on platforms, including Envestnet.

"We get a lot of requests from brokers or advisers for materials, and we provide what we can," Mr. Sumnicht said. "Am I going to put a couple guys on an airplane and send them to your office for a couple hours and pay for lunch? No, I can't do that."

But larger firms have more-substantial marketing capabilities and access to platform gatekeepers.

Windhaven was purchased by The Charles Schwab Corp. in 2010. It enjoys the support of ETF firms including BlackRock Inc., which sees it as a primary client.

"This continues to be the fastest-growing area for us," Mr. Gamba said. He said BlackRock's largely passive benchmark-tracking products benefit from the interest of active managers and traders such as strategists. "It's a distribution outlet for us to get to end-clients who want to express their views through ETFs."

But many of the firms continue to see themselves as plain old asset managers, even though they invest primarily in ETFs.

"We use ETFs because right now, they're the most efficient vehicle for us," said Brad Thompson, chief investment officer at Stadion Money Management. "If there happened to be a better vehicle, we might use it too."

"I'm not married to ETFs; I just happen to use them," Mr. Stein said.


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