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October 01, 2006 at 04:00 AM
In the last few years, exchange-traded funds have bloomed and flourished as the white-hot darlings of Wall Street.
Indeed, trendy ETFs — much advertised and widely hyped in the consumer press — are even surfacing in cocktail-party chat. Yet oddly, most investors would be hard pressed to explain just what an exchange-traded fund is. All the more surprising, many financial advisors haven’t even bothered to learn ETF basics, let alone how to integrate these versatile vehicles into client portfolios.
Since their debut 13 years ago, ETFs — funds that can be traded like individual stocks — have shown explosive growth, with assets today reaching about $350 billion. Plus, new ETFs are scrambling to the market at a non-stop clip. Totaling some 250, they include sizzling gold ETFs and those tied to countries like Canada, Brazil and Australia.
ETFs’ main advantages are by now familiar: liquidity, tax efficiency, lower expenses than mutual funds — and they’re clearly ideal for diversification.
To be sure, with their outstanding financial-planning and monetary benefits, exchange-traded funds make life easier both for advisors and retail clients — affluent as well as middle-class investors — and institutional accounts, too.
Research recently talked with three ETF-savvy industry pros, who offered a wealth of insight into how these dynamic new-age products can best be put to work.
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Mitchell SlaterPartner, The Slater-Trainor Team
Smith Barney, Florham Park, New Jersey
Mitchell Slater has one gentleman client who phones him the first of every month: “Where in the world are we going now?” he asks the financial advisor eagerly.
What he means: Where are we going now to invest in international ETFs? Because with Slater’s model portfolio, each month usually brings a strategic change. “[Last August], for instance, we took out Austria and South Korea, and added France and Italy. Clients absolutely love that,” says the senior vice president-wealth management. His mostly fee-based team of four manages about $150 million in high-net-worth client assets, a sizable $40 million of that in ETFs.
Slater is a long-time ETF fan: He started out with HOLDRs, SPDRs and BLDRs nearly as soon as they debuted. At the time, he was with Merrill Lynch. “I had strong demand from clients who wanted to look at ETFs. I approached Merrill a number of times for an asset-allocation model portfolio, but they basically had no research analysts in that arena. So,” says Slater, “I had to look outside. Smith Barney was the only firm that had research, and I was able to use their domestic and international portfolios.”
Smith Barney’s ETF platform is in fact a major reason Slater moved his practice there from Merrill a year ago last January.
ETFs “absolutely make managing assets easier,” says the FA, 45. “With an ETF asset-allocation model, you can look at valuations a little more and understand that, unlike individual securities — with high betas and a lot more risk — the sectors fit into what’s happening in the economy domestically and globally.”
Slater especially likes the model portfolios’ recommended weighting breakdown vs. the S&P 500. “In health care, for example, our weighting is 20 percent; the S&P’s is 12.2 percent. Merck has gone from 25 to 42. An ETF was a great way to take advantage of that without owning just Merck. The same thing goes for being overweighted in the energy sector the last couple of years, or being underweighted in consumer staples.”
Capturing assets in ETFs that clients’ previous advisors had put in mutual funds has brought a sharp increase in Slater’s business. “A lot of brokers still have clients in ‘B’ shares. ETFs are a much better tool,” he says. “They’re lower in cost and are more tax efficient. I’d be happy any day to put the top 10 mutual funds out there vs. ETFs. It would be a pretty good battle!”
But, warns the advisor, ETFs “aren’t a panacea. You can’t just go out and pick the 10 highest trading ETFs every day and just expect that they’re going to make money. You’ve got to be [at least] somewhat active with them. Trends change, and you must be on top of them. For instance, if the Fed is done raising interest rates, you want to own financials.”
According to Slater, diversification is key. In many ways, “you run the same risks with index ETFs as owning the S&P. You want to buy an entire market or sector, an industry, a country, or a region — and get the kind of liquidity that ETFs have.”
As for performance, Slater’s international portfolios have been “significantly beating” the S&P, he says; and his domestic model has had higher numbers as well, up just under 20 percent as opposed to the S&P’s 15 percent.
Further, Slater lauds ETFs as a terrific prospecting and referral tool. “Because of their tax efficiency, they typically make more sense than mutual funds for retirement accounts. That’s why I get a lot of referrals from accountants: They really love ETFs,” he says.
Slater’s advice to fellow advisors: “Be cautious about new ETFs coming to market. Some are closed-end funds hiding as ETFs; they’re not really tracking indexes or sectors.
Stick with the ones that have been time-tested. Investing folks’ money in things you don’t understand yourself is not a good idea.”
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John P. O’Leary
Westfield Profit Formula Group
Wachovia Securities, Mountainside, New Jersey
Weekends find John P. O’Leary basketball-coaching his three kids and poking around antique stops with wife Karen. So much for chilling out. At work, the financial advisor is a driven man. What drives O’Leary is a passion to help his high-net-worth retail clients — especially new ones — increase their returns while lowering their risk.
In the first quarter of this year, O’Leary, 45, moved into ETFs. The product has lifted clients’ investment performance and, he says, boosted his business “enormously.”
“They’re something different to talk about to clients. ETFs can be explained in such a way that they really understand what this product can do to help them achieve goals and provide instant diversification. It’s a compelling story,” says the Wachovia managing director, who, with a partner, runs a six-member fee-based team. They manage $300 million-plus in assets, the bulk in managed accounts.
O’Leary has embraced Wachovia’s ETF Advantage Portfolio program, which uses an actively managed separate account approach to strive for a combination of strategic as well as tactical asset allocation.
“It’s a win-win for the clients,” says the FA, noting that ETFs boast lower expenses. “They’ve helped our assets grow in a big way. We probably add seven figures-plus in [ETFs] every month.”
O’Leary puts together ETF programs weighted in a variety of areas and divided by sectors. But if he sees momentum in a certain area, he’ll shift into that one and out of another.
