From the December 2012 issue of Investment Advisor • Subscribe!

Rise of the ETF Asset Managers

As an ETF strategist, much of my time is spent parsing the differences between funds in an ever-increasing universe of exchange-traded funds (and other ETPs). While I believe industry growth and innovation is healthy, it’s easy to see why many advisors find the challenge of sorting through and effectively selecting a portfolio of ETFs overwhelming. Perhaps this helps explain the rapid growth of third-party ETF asset managers over the past few years. According to Morningstar, which tracks around 490 strategies from 120 firms with assets of $50 billion (as of June 2012), assets in these types of accounts increased by 30% during the first half of 2012. They increased 48% since September 2011. What is it about ETFs that asset managers have come to find so appealing compared to individual securities?

While ETFs have come to serve a variety of purposes for asset managers, those who have most increased their usage of ETFs often provide very similar reasons for doing so. Frequently, potential cost-savings is near the top of that list. It may seem counterintuitive that a packaged investment like an ETF would be less expensive than utilizing individual securities, but after considering the custodial and trading costs for individual foreign securities, certain international ETFs may provide significant savings. According to David Allen, portfolio manager at Accuvest Global Advisors, which manages about $440 million, his firm “views single-country ETFs as the most cost-efficient way to gain access to the markets in countries that we believe are most attractive.” Another attribute of ETFs that many large asset managers are beginning to appreciate is the potential for better liquidity. For active managers operating in a world where new information is disseminated in moments rather than minutes, liquidity has become paramount.

“The ability to move quickly when markets move is a big advantage of ETFs for a tactical manager,” explained Jeff Hays, president of Hays Advisory, which manages about $850 million. “While it may take a week or two to work out of a large position in certain individual stocks, I can execute a large ETF trade in a matter of seconds.”

For some asset managers, ETFs simply fit better within their overall investment philosophy. ETFs allow portfolio managers to efficiently implement macro strategy calls, without focusing on the selection of individual securities. Such is the case for Neil Peplinski, portfolio manager at Good Harbor Financial, which manages about $3.3 billion in ETF portfolios, who views ETFs as useful portfolio management tools. “The underlying premise to our strategy is that what really drives equity prices in the short term has less to do with companies’ fundamentals and has more to do with appetite for risk,” he said. By utilizing ETFs, asset managers like Good Harbor can focus their attention on the variables they deem most important, rather than individual security selection.

Of course, the other half of the equation in seeking to understand the recent growth of ETF asset managers is why these strategies are so attractive to the financial advisors through whom many investors have been introduced to these accounts. While some advisors have the expertise, resources and time necessary to effectively manage hundreds of client portfolios on a discretionary basis, most do not want to be portfolio managers. Instead, many advisors are transitioning toward fee-based financial planning, providing a variety of financial services rather than just portfolio management. For those who have recognized the benefits of ETFs versus traditional mutual funds, ETF managed accounts provide an efficient way for their clients to incorporate ETFs within a comprehensive financial plan.

The recent inflows for ETF asset managers have been impressive, but we may still be in the early stages of this trend. As more asset managers begin to recognize the benefits of utilizing ETFs for portfolio management, and as financial advisors continue to move toward fee-based financial planning with outsourced asset management, the prospects for growth appear strong for ETF managed accounts in the years ahead.   

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