As exchange-traded funds grow in popularity, more financial advisers are using model ETF portfolios as a low-cost way of managing their clients' money
As exchange-traded funds grow in popularity, more financial advisers are using model ETF portfolios as a low-cost way of managing their clients' money.
The use of professionally constructed portfolios, which enable clients to invest in ETFs that match their risk tolerance, has grown substantially. Morningstar Inc. tracks more than 200 model ETF portfolio programs holding more than $10 billion in assets, and is creating a database of model portfolios, based on information submitted by firms.
“It's a hard market to track,” said Morningstar analyst Andrew Gogerty.
Advisers are also turning to ETF model portfolios as they look for help with asset allocation, said Jeff Strange, an analyst at Cerulli Associates Inc.
“The market crisis put greater emphasis on risk management within portfolios,” he said. “The traditional 40/60 split in the portfolio is being replaced by bringing in more asset classes, and ETFs are a good way of doing that.”
For broker-dealers, who may receive a share of the manager's fee, offering model portfolios of ETFs provides a way to profit from the shift away from mutual funds, experts said.
Model portfolios allow independent advisers to relinquish to professionals the fiduciary responsibility of managing money. Fee-based advisers find them attractive because the lower cost of ETFS, compared with open-end mutual funds, protects their margins.
“You may not get the revenue share that you get from mutual funds, but you are providing a better experience for the client, and in the end, that should lead to winning more clients,” said Michael Jabara, an ETF research analyst at Morgan Stanley Smith Barney LLC, which offers model ETF portfolios.
FIRMWIDE PROGRAMS
Last year, Charles Schwab & Co. Inc. bought Windward In-vestment Management Inc., a provider of model ETF portfolios, in response to demand from advisers, said Bryan Olson, senior vice president of Windhaven Investment Management Inc., the new name for Windward.
“More breakaway brokers who were in the business of client relationship management but are now going independent came from firms that had more centralized investment research and approved lists,” Mr. Olson said. “They understand that replicating that function themselves is going to take a lot of time.”
Windhaven offers three model ETF portfolios with $6.7 billion in assets under management. The portfolios — conservative, growth and aggressive — each have 10 to 15 ETFs and carry a management fee of 50 to 75 basis points, on top of the 25 to 30 basis points for the underlying ETFs. Retail clients who buy Windhaven model ETF portfolios pay a management fee of 95 basis points, Mr. Olson said.
Wells Fargo Advisors LLC has streamlined the exchange-traded-fund model portfolios for its more than 15,000 advisers, lowering the costs of some models.
Previously, Wells Fargo offered about 40 ETF model portfolios with 100 ETFs, which it largely inherited when its parent, Wells Fargo & Co., acquired Wachovia Corp. in 2008, said Kurt Loreck, senior vice president and director of internally managed accounts at Wells Fargo Advisors.
“The consolidation will make it easier for the financial adviser to navigate the differences between the models,” Mr. Loreck said.
In the new Allocation Advisors program, Wells Fargo's advisers can choose among 27 models in three categories: tactical, cyclical and strategic. The nine models within each category range from long-term growth to conservative income.
The cyclical models are based on outlooks over a three- to five-year period. The strategic models are based on the firm's capital markets assumptions with a seven- to 10-year outlook. The tactical-allocation strategy is based on short- to medium-term opportunities in different segments of the market, Mr. Loreck said.
Wells Fargo also has lowered the costs of some of the models to 2%, from 2.25%. The Allocation Advisors program has more than $8 billion in assets under management.
In March, RiverFront Investment Group LLC, a $3 billion money manager that has been publishing model ETF portfolios free of charge since 2003, started selling two discretionary model ETF portfolios to advisers. The two global-tactical allocation portfolios have $100 million combined.
One follows a growth-and-income strategy, while the other is more aggressive, said Michael Jones, chairman and chief investment officer of RiverFront. The management fee for the portfolios is 25 basis points, on top of the underlying expenses of the ETFs, which range from 30 to 60 basis points.
As more independent advisers start using model ETF portfolios, providers are helping out. For example, The Vanguard Group Inc. helps its advisers assess the ETF portfolios they are using, said Jack Brod, head of U.S. sales and distribution for Vanguard's financial adviser services group.
“We look at where they might be underweight or overweight certain asset classes and provide an independent third-party miniconsultation,” he said.
BlackRock Inc. tracks 76 managers offering ETF model portfolios, up from 25 in 2008.
It's very important that advisers understand how managers set the asset classes the way they do, Mr. Brod said. “Cost, tracking error and reputation becomes increasingly important,” he said.
As with any investment trend, potential buyers should proceed cautiously, particularly as more advisers get into the business of selling their own model ETF portfolios, Mr. Gogerty said.
SEC SCRUTINY
Last year, the Securities and Exchange Commission said it was looking into the burgeoning business of financial advisers' selling ETF model portfolios.
“These models are all over the map,” said David Nadig, director of research at IndexUniverse.com. “And advisers need to understand what value they are getting.”
One issue that has cropped up as more advisers start publishing model ETF portfolios is that many are touting performance they can't really claim.
Instead of actual performance, some advisers are promoting back-tested performance, which is hypothetical, said Richard Ferri, founder of Portfolio Solutions LLC.
“I haven't seen any back-tested performance that didn't outperform,” he said.
And if the performance is factual, advisers should make sure that it is based on client returns, and not just on the model's return, experts said.
The CFA Institute's global investment performance standard Ticker:(GIPS), which was created to measure the performance of individually managed portfolios, measures client returns and should be something advisers ask for, Mr. Gogerty said.
“You don't have everyone getting the same data point for performance like you would with an open-end fund,” Mr. Gogerty said. “Advisers should be checking if the performance is GIPS-compliant.”
And if all that adds up, advisers still need to make sure that the managers are using the right benchmark, Mr. Ferri said.
“A lot of the times, even if they come up with the right performance, they will use the wrong benchmark,” he said.
To help advisers sort out the field, Morningstar plans to launch ETF model portfolio rankings within the next few months.
“There isn't a road map for advisers to choose strategies,” Mr. Gogerty said. “We are hoping to address that.”
