New tack with tactical allocations an eye-opener

Advisers interested in tactical allocations can take a page from the playbook of large institutional investors. Institutions increasingly are turning to exchange-traded funds to make their tactical bets on broad markets and specific asset classes, according to a new study by Greenwich Associates. The study found that 57% of institutions are using ETFs to make tactical bets, up from 50% in 2011. “It's no longer about the ‘active versus passive' debate,” said Loc Vukhac, head of iShares' asset management and hedge fund group. Instead, institutions are using ETFs, which are predominately passively managed and track a benchmark, to make active bets intended to help the managers outperform benchmarks. Liquidity is the main reason institutions are turning to ETFs for tactical purposes. With ETFs, an institutional manager can overweight an asset class and move in and out relatively easily. For instance, if a managers thought that Japan was oversold following 2011's earthquake, they could have bought a Japan-focused ETF in a single trade and held it until they felt it was properly valued. If managers had tried to buy the securities individually, the strategy would have incurred far more transaction costs. If they had tried to buy a Japan-focused mutual fund, getting out would not have been as smooth. “It's detrimental to a mutual fund to have investors going in and out quickly,” said Sue Thompson, head of iShares' RIA group. “If an adviser tried to do that, they'd likely have their hand slapped by the fund company and not be able to get back in,” she said. While the liquidity is what makes the tactical moves possible, when it comes to picking an ETF, cost is still king. Almost three-quarters of institutions rated the expense ratio as the most important criterion in selecting an ETF, according to the study. There are other factors that can affect ETF cost beyond just the management fee, Ms. Thompson said. The liquidity of the ETF, its ability to track its benchmark and tax efficiency are important considerations, as well.