What does a world class ETF investment advisory practice look like? How does it get built? And how can advisors position their businesses for the next wave of growth?
Research spoke with four leading advisors from across the U.S. about their views. We asked them about their ETF businesses and how they’ve managed to separate themselves from the pack. Along with sharing their success formulas, they share valuable insights about today’s ETF marketplace and where things are headed.
Douglas Wolfe, Principal and CIO at Saddle River Capital Management ($30 million AUM) in Saddle River, N.J.
Hugh Fitzpatrick, CEO at Princeton Capital Management ($115 million AUM) in Princeton, N.J.
Jeffrey C. Anderson, Jr., Sr. Vice President, National Sales Manager at Efficient Market Advisors ($305 million AUM) in San Diego.
Michael A. Gayed, CFA, Chief Investment Strategist at Pension Partners ($127 million AUM) in New York.
How do you differentiate your ETF advisory practice from the competition?
Anderson: Primarily, we are an outsourced solution for advisors looking to create scale in their practice by utilizing a turnkey asset management solution as opposed to being a local market RIA. Secondarily, we are different from our peers because we utilize a “liquid endowment model” combing strategic, tactical and opportunistic allocation into all our portfolios.
Gayed: While many may use ETFs as a low-cost alternative to mutual funds as part of a passive overall asset allocation, Pension Partners uses them to actively and tactically buy and rotate across various segments of the investable landscape. Through the use of our ATAC models used for managing our mutual fund and separate accounts, we have the ability to quickly and efficiently completely reposition our asset allocation exposure in a single day, altering what we are tracking based on market conditions and intermarket trend movement.
Wolfe: We build our own portfolios. When we first started our practice in 2004 we wanted to stand apart from other advisors. We had a strong background in research and trading, and we had a very good understanding of a fairly new product at the time, exchange-traded funds. We thought that if we could be “the expert advisors” in this new product that would be enough to differentiate ourselves from most. We put together five ETF portfolios, based on client risk categories, and placed our clients in them. So, we can now be called an asset manager as well. Our practice is now almost 100% dedicated to exchange-traded funds.
Fitzpatrick: The broker-dealer community is additionally resisting the move by regulators and consumer activists to impose fiduciary obligations on registered representatives. The instinct is to offer bland, standardized financial products that will be “safe” by being formulaically diversified and conservative. As the large firms drive to protect themselves from legal liability “when things go wrong,” they are standardizing financial products more and more. The goal is protecting the broker-dealer and the investment advisor from liability; the trade-off lowers the investors’ likely returns in order to lower the vendors’ risks. This approach is particularly damaging to investors when the compounding effects of time are factored into the equation. The flight from liability by large investment managers and large broker-dealers creates the independent investment advisors’ opportunity.
How do you decide which specific ETFs to use to build portfolios?
Anderson: Our screening process begins with the universe of approximately 1,200 U.S. based ETFs. For us, the primary considerations are structure, liquidity and cost. We then focus on long only, non-levered ETFs of the traditional cap weighted indexes. It’s important for us to focus as much as we can on the allocation as opposed to trying to be too creative around the construction of the index.
Gayed: Our models primarily focus on broad based equity and bond segments, allowing us to target multiple inexpensive ETFs which track those areas for our clients. By spreading out our investments across several ETFs, we can more efficiently rotate large sums of money and help diversify away some of the tracking error risk that might otherwise occur through such an active strategy.
Fitzpatrick: We find the current tools for understanding ETFs inadequate. We struggle to understand what we want to buy. We view our first task as understanding the building blocks, that is the individual ETF. We are hopeful that Stock Smart’s (developing) new analytical approach will let us both “unzip” an individual ETF and see what is in it and then compare that ETF to others in analytically meaningful ways, as well as “unzip” a whole portfolio of ETFs and then “merge” them to see what the portfolio actually owns. ETFs can also be combined with stocks to create the clearest picture of ownership, diversification and risk exposure.
Wolfe: We had a strong research background, so decided to come up with a research process that would break down each ETF by its underlying constituents and score each ETF by a number of fundamental and technical indicators. The ETFs that score in the top of their asset classes are the only ones considered when building the portfolios. We also have incorporated a number of outside research products into our process to act as a check against our own research.