The special qualities of exchange-traded funds continue to make them a preferred investment vehicle for financial advisers. In fact, according to the Journal of Financial Planning's 2015 Trends in Investing Survey, ETFs have overtaken mutual funds as the most popular investment vehicle employed and recommended by advisers.
While ETFs' tax benefits, low fees and intraday liquidity are certainly well known, positioning them in a managed portfolio is one of the fastest-growing tactics in the managed-account universe. Advisers are not only using managed ETF portfolios to take advantage of the inherent ETF efficiencies, but to also manage risk in a way that has never been done before.
Managed ETF portfolios are investment strategies that typically have more than 50% of portfolio assets invested in ETFs. As a basic tenet, ETFs protect investors from a common pitfall in the financial adviser community — single company exposure. A basket of ETFs, therefore, provides even greater portfolio diversification, expanding exposure to more securities within a particular asset class.
TOO MANY SURPRISES
Despite exhaustive analysis and good-faith work, advisers know there are just too many surprises in today's markets — corporate transgressions, executive health problems, unexpected litigation — which all the research in the world can't prevent.
(More: Why ETF managed portfolios are rapidly gaining in popularity)
Clearly, a diversified investment portfolio is the right path for advisers to follow, but why should they favor the ETF's passive investment strategy of mirroring a specific index over actively managed mutual funds designed to beat particular benchmarks?
The answer is that advisers investing in a managed ETF portfolio have access to ETF strategists, many of whom actively buy and sell ETFs to maximize returns and minimize risk. These strategists are, in fact, active managers using passive products to maximize returns.
Within just a few years, the ETF investment strategist industry has developed into approximately 700 strategies employed by more than 150 firms with assets totaling $86 billion, according to Morningstar Inc.
In addition to the lower cost structure and liquidity of ETFs, strategists help navigate the evolving ETF landscape with minimums as low as $25,000 to provide investment analysis and advice on portfolio construction, asset allocation and tax structure.
Supporting the growth of ETF strategists has been the change in unified managed account technology seen on Envestnet,
Charles Schwab and other platforms, whereby a strategist can deliver a portfolio of assets, acts as custodian and trade the assets. These streamlined platforms align perfectly with the trademark low-cost ETF strategies so appealing to fee-based advisers.
NEW WAY TO MANAGE RISK
Further, managed ETF portfolios provide innovative risk management techniques that lend themselves to a quantitative approach to investing. Never before has risk been able to be managed this way — using either a strategic approach with sector exposure or a tactical method, taking advantage of short-term trading opportunities, whether the markets are good or bad. Regardless of investment objectives, the ability to trade ETFs within a managed portfolio allows strategists to be nimble and take advantage of opportunities that are simply out of reach to traditional mutual fund investors.
(More: How to make ETF transparency work for you and your clients)
A managed ETF portfolio, in effect, provides broad exposure to any asset class that a quantitative model signals as opportunistic.
Additionally, a managed ETF portfolio gives financial advisers more time to focus on maintaining client relationships and developing new business by outsourcing the investment side of their business and providing advisers with the flexibility to build their practices. Recent reports also indicate that clients are receptive to outsourcing investment activities.
In a survey published last year, Northern Trust Co. found that 70% of advisers who outsource investment management reported their decision was well received by clients and often led to business growth. Further, 80% of advisers reported they didn't lose any clients because of outsourcing, the survey noted.
As the ETF industry continues to take shape and more investment professionals realize the benefits of managed ETF portfolios, innovation is likely to present even more opportunities for growth. The low costs, liquidity and tax benefits of ETFs coupled with the dynamic risk management tools of a managed ETF portfolio will change the investment landscape for years to come.
Jeff Montgomery is chief executive of AFAM Capital.
