Disruption, Increased Advisor Input and More Active Products: ETF Roundup

“It’s no longer just about a 60/40 [stock/bond] portfolio with some international product and a fee added,” he said. “But there are always two sides to a trade [with ETFs], so you have to pay attention. That’s why the advisor as fiduciary is important — to help clients make choices.”

Having more exchange-traded products means there are “better opportunities and outcomes” for investor clients and advisors alike, he said.

As members of the panel agreed, with new products such as leveraged funds come new risks, and this means makers of such products need to ensure that the risks are clear and fully understood by investors.

“We want to give choice in a responsible way, and we want people to have the right portfolios and products,” given their risk profiles and other characteristics, said Sanjay Arya, Morningstar’s head of indexes.

“It’s about educating investors and getting them to understand what is in the products,” Tobin said. “In the past, some have not understood what they were buying, and we had to back away from [such ETFs].”

While some sophisticated leveraged instrument might make sense for an individual, others might not.

“We want to know why you are taking that position, since we want responsible choices and outcomes for an investor.”

For many investors, broad bond, domestic equity and international funds work just fine. But what about younger investors who want to do more speculation?

“There are packaged solutions, and advisors do that. They can also help people with behavioral insights, so they don’t panic,” said Rodney Comegys, head of Vanguard’s Equity Index Group.

Many investors can have nearsightedness when it comes to the markets, he pointed out. And with the spread of robo- and hybrid advisors, advisors have a role to play in helping clients by coaching them to “keep their focus on the long term” and to remember the role that ETFs play within their larger financial plan.

Liquidity, Volatility & Customization The industry also faces challenges tied to liquidity in volatile times.

“In times of low volatility, people focus on the … cost proposition of ETFs,” Tobin said. “But in times of more market volatility, people want to see liquidity, and trading volumes kick up dramatically.”

In such a context, investors are taking a hard look at liquidity, the total cost of ownership that includes the ease of trading — not just a fund’s expense ratio.

Many investors are asking, “How quick can I make a risk on/risk off trade and what is bid-ask spread? There was about $11 trillion in turnover for SPDR ETFs last year,” Tobin explained. Looking further out, Comegys said, advisors can add value via helping clients by building model portfolios and customizing full portfolios:

“For individual investors, this is where cost and competition will come in the next 10 years.” Alpha-focused discussions are becoming a thing of the past, he adds.

More Active ETFs Coming To Market There will be more actively managed and eventually even nontransparent ETFs coming to market in the future, but not every strategy lends itself to that structure, according to speakers at the Inside ETF conference.

Actively managed ETFs have a better risk profile in less efficient markets but don’t belong in funds focusing on alternatives, said Shana Sissel, portfolio manager at CLS Investments.

They provide more choice for investors, especially for taxable accounts, said Dodd Kittsley, national director at Davis Advisors funds, whose current ETF lineup includes active and passive funds.

But for actively managed ETFs to succeed, price will be key — not too expensive for investors but not so cheap that funds cannibalize the funds they already market.

“The dirty little secret” in the mutual fund industry is that “mutual funds are priced too high,” so an actively managed ETF that’s similar to an actively managed fund but with a lower price point would not be palatable to fund companies’ boards, Kittsley said.

If an actively managed ETF can deliver on performance, however, price will be less of an issue, said Noah Hamman, CEO of AdvisorShares, an investment management firm that offers only actively managed ETFs. But Hamman stressed that fund managers must be mindful when they set their price for an actively managed ETF.

Fund companies offering actively managed ETFs ideally should have a strong track record for performance and a high level of active shares, and the managers of the actively traded ETF should own shares of the fund, Kittsley said.

Morningstar research in 2015 found that fund managers who had invested more than $1 million in their own funds tended to have more success than other managers. Forty-eight percent of their funds survived and outperformed their peers over a five-year period compared with 32% of other funds.

Actively managed ETFs, like actively managed mutual funds, also should live up to their name, according to the panel.

“We don’t need an active ETF that’s a closet indexer,” said John Lunt, president of Lunt Capital Management.

Most of the panelists agreed that when — not if — nontransparent ETFs enter the market, there will be a flood of new actively traded ETFs. “More managers see the advantages of the structure,” Sissel said.

ETFs currently must disclose their holdings daily, which is why it’s been said fund companies are hesitant about developing actively managed ETFs. They fear disclosure of their “secret sauce” and front running by competitors, explained Kittsley, but he said those fears were overblown. He said he hasn’t experienced either with Davis’ actively managed equity ETFs.

Kittsley expects to see a “semitransparent” structure for actively traded ETFs rather than a nontransparent one. “Every asset manager has to have an ETF strategy.”

Janet Levaux is editor-in-chief of Investment Advisor. She can be reached at [email protected]. Bernice Napach, senior writer for ThinkAdvisor.com, can be reached at [email protected].