Broadly speaking, the growth of ETFs is outpacing that of traditional mutual funds. What’s more, personal finance publications frequently tout the merits of ETFs so the general public is increasingly becoming familiar with the products’ advantages.
At the same time, many advisors are using the products to cut down on their portfolio management expenses while managing risk. Market watchers maintain that investors are flocking to ETFs because the products offer low fees.
Currently, the lion’s share of ETFs track indexes. As such, they are appealing to investors who favor passive investing. Other investors may be attracted to the ability to make intraday trades with ETFs and to the products’ high tax efficiency.
For advisors, the growing popularity of ETFs presents a handful of issues as well as opportunities. On one hand, advisors who don’t use ETFs, or use them for only limited purposes, need to be prepared to respond to client inquiries about the products.
The products, of course, are primarily passive, or index, based. That means advisors who advocate using actively managed products must be well prepared to justify the merits of stock picking when pursuing new clients who are ETF fans. In doing so, advisors may want to highlight mutual funds that they use that have long-term track records of outperforming market benchmarks.
While no performance results can be guaranteed, potential for long-term market outperformance, they should add, can help increase investors’ chances of reaching their savings goals. At the same time, they can argue that index investing resigns ETF users to only capturing market performance.
Advisors can also maintain that higher fees associated witch active management are justified when portfolio managers outperform their benchmark or produce attractive risk-adjusted returns. Advisors who advocate active portfolio management may also be able to win over advocates of ETF by pitching a hybrid approach that uses both active and passive products.
The strategy could include using ETFs for the most efficient categories, such as U.S. large cap equity assets, and active management for less efficient categories, such as international, emerging markets and U.S. small cap. Advisors can pitch such strategies as offering the best of both worlds—the passive products can help keep overall fees low while the active products can help enhance performance relative to market benchmarks.
although at $1.5 billion in assets, according to the Wall Street Journal, such offerings are very limited at this time. The growing popularity of ETFs, meanwhile, is an attractive tailwind for advisors who already use the products. Such advisors can promote the merits of the products as well as the advantages of having professional help for building portfolios of ETFs.
Advisors should be prepared to explain how they can customize risk and return potential. In the case of tactical asset allocators, advisors can pitch how they determine weightings of different asset classes and how overweighting of asset classes with the most attractive valuation may help to reduce risk.
Advisors can also promote how their research can help identify the most appealing products. For example, at least three ETFs are available that track the S&P 500 Index, so advisors can illustrate how their research has determined which of three products is the most appropriate for individual clients.