From the August 2013 issue of Investment Advisor • Subscribe!

Advisors Struggle to Understand ETF Liquidity and Trading

Cerulli concludes that ETF sponsors should work harder on education efforts to increase advisor adoption of exchange-traded products

When it comes to knowing how exchange-traded funds work, ETF sponsors report that financial advisors have the hardest time understanding liquidity and trading, according to research released in July by Cerulli Associates.

A total of 63% of ETF sponsors rated liquidity as their top growth challenge in 2013 because of advisors’ limited knowledge of the topic, Cerulli reported. Understanding how ETFs trade got the second-lowest ranking, and how ETFs are structured was third lowest. Meanwhile, ETF risks and the use of ETFs in portfolio construction ranked as the top two topics that advisors understand best, followed by tax treatment.

“Liquidity and trading ranked the lowest, suggesting these two topics should remain top of mind for providers when developing educational programs,” said Cerulli Associate Director Alec Papazian in a statement.

The Boston-based global analytics firm concluded in the July 2013 issue of “The Cerulli Edge—U.S. Asset Management Edition” that ETF sponsors should do more to educate advisors in order to further increase advisor adoption of exchange-traded products.

“As the market matures and ETF investing spreads beyond its foundation of core domestic equity indices to categories such as fixed income, international equity, and products including alternative weightings (i.e., volatility weighting, equal weighting), sponsors are finding the need to create educational materials and programs for both new and advanced users of the products,” according to the report.

Sponsors disagreed on the single largest inhibitor to ETF adoption, splitting evenly between insufficient platform support, inadequate knowledge of ETF use in portfolio construction and reluctance to reallocate existing client positions to ETFs.

Cerulli’s research found that the percentage of advisors using ETFs by channel broke down as follows in 2012:

  • Wirehouse, 63%
  • Registered investment advisor (RIA), 55%
  • Bank, 44%
  • Dually registered, 42%
  • Regional, 42%
  • Independent broker-dealer (IBD), 39%
  • Insurance, 24%

Creating programs to meet the educational needs of these advisors across the spectrum of adoption and sophistication “is a difficult task, but it will be necessary for some time,” Papazian predicted.

The type of assistance that advisors require from ETF sponsors varies widely, Cerulli found. Among advisors who now use ETFs, 34% cited evaluation tools as the most valuable type of support from sponsors. Another 22% cited education on incorporating passive strategies into tactical allocation, and 16% cited client-approved educational material about ETF basics.

For advisors who don’t use ETFs, 27% cited client-approved educational material as the most valuable type of sponsor support, while another 27% cited education on trading ETFs and 17% cited evaluation tools.

Notably, Cerulli reported that although it’s not offered by ETF sponsors, the Index Universe ETF Analytics tool, which launched this year, rates and evaluates every ETF and exchange-traded note on the market using proprietary data points. The tool includes ratings for tradability and efficiency such as the fund’s ability to meet its stated objectives.

“This can be a valuable tool for advisors who are heavy users of ETFs, but with overall advisor allocations to ETFs at only 7.1% on average as of 2012, there will be a significant group of advisors for which subscribing to the tool is not practical,” Cerulli noted. “Support in this area from sponsors can be an important factor in driving increased allocation to ETFs in portfolios.”

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