InvestmentNews has learned that the Securities and Exchange Commission is examining the burgeoning business of financial advisers' selling model portfolios of exchange-traded funds.
“The practice has come to the attention of the staff and they are looking at various aspects,” John Heine, an SEC spokesman, wrote in an e-mail to InvestmentNews.
Model ETF portfolios, in which advisers manage a portfolio of securities for other advisers or investors, have rapidly grown in popularity in recent months as people turn away from traditional mutual funds.
And with the explosion of ETFs coming to market and the pending 12(b)-1 reform proposal, industry observers predict demand for model portfolios will continue to swell as more advisers adopt fee-based business models.
Specifically, with model ETF portfolios, advisers can offer lower-cost options than actively managed funds.
The average total operating expenses for an asset-weighted actively managed domestic equity fund was .92% as of last year, compared with 30% for a domestic equity ETF, according to Strategic Insight.
Some industry experts worry, however, that many of the advisers offering these model portfolios aren't sophisticated enough to do the proper due diligence on the underlying exchange-traded funds. In the long run, they say, investors could get hurt.
“Everyone and their brother have a model portfolio, and of course every model portfolio has outperformed the market, which is complete nonsense,” said Richard Ferri, founder of Portfolio Solutions LLC, a registered investment adviser who manages $800 million in assets. “The trouble is there is no verification of most of these models because they didn't exist two years ago. There is no history.”
Officials from Finra have approached Mr. Ferri and Scott Burns, an analyst at Morningstar Inc., about their concerns about the use of ETFs -- and model portfolios did come up in the conversations, Mr. Ferri said.
“I did talk about it with the Finra people and they are aware of the issue,” he said.
“One of our gripes to the Securities and Exchange Commission and the
Financial Industry Regulatory Authority is that there is no regulation,” Mr. Burns said. “People are out there pitching portfolios saying they have beaten the Standard & Poor's 500 Index, but if those portfolios are 4% fixed income and 10% gold, they could have owned three ETFs and had the same results at lower costs.”
Mr. Heine declined to comment beyond confirming the fact that the SEC is looking into the issue.
