Mutual funds and exchange-traded funds might belong to the same general family of investments, but research increasingly suggests that ETF investors make better clients for financial advisers than mutual fund investors.
According to a compilation of research from Cerulli Associates Inc. and the Investment Company Institute, investors who use ETFs tend to be wealthier, younger and better-educated — fitting most advisers' description of an ideal client.
“Your more sophisticated clients understand the value of ETFs,” said Tom Lydon, president of Global Trends Investments. “So if you're an adviser who is not using ETFs, your sophisticated and wealthier clients will want to know why. If you're a financial adviser who is embracing ETFs, you're ahead of the curve.”
CAPTIVE AUDIENCE
“ETFs are attracting a crowd that understands the benefits of indexing,” said Christian Magoon, an industry consultant and chief executive of Magoon Capital LLC. “Because people have to make more of an effort to seek out ETFs, the ETF investors tend to be more engaged,” he added. “And they are finding ETFs to be a better option.”
The ICI's research shows that the median household income of mutual fund investors is $80,000, compared with $130,000 for ETF investors. Similarly, the household financial assets median is $200,000 for mutual fund investors and $300,000 for ETF investors. The median age of the head of the household is 50 for mutual fund investors and 46 for ETF investors.
“In some respects, you could think of ETFs as digital music, in terms of the way they represent the emerging and disruptive technology,” Mr. Magoon said.
Early adopters among financial intermediaries tend to be independent financial advisers, according to Cerulli.
While ETFs represent just 7% of all assets under advisement across all distribution channels, the percentage of ETFs is at 16% among independent advisers, Cerulli found. Regional and wirehouse representatives are the second- and third-largest users of ETFs, with 10% and 9% portfolio allocations, respectively, on average.
Bank and insurance representatives are much more likely to steer clear of exchange-traded funds, with ETF allocations closer to 3%.
By comparison, mutual funds represent 41% of all assets across all distribution channels, with average allocations ranging from 31.4% in the wirehouse channel to 53.5% among independent-broker-dealer representatives.
“This shows that advisers, for the most part, still believe in active management [through mutual funds],” said Scott Smith, an associate director at Cerulli.EXPENSES MATTER
“But for the [independent advisers], there is more of a focus on low expenses that come with ETFs,” he added. “With a lot of the advisers using more ETFs, the asset allocation part is where they feel they are adding value.”
Cerulli's research also revealed that nearly 53% of advisers across all distribution channels expect to start increasing allocations to ETFs. Mr. Smith cautioned, however, that “advisers tend to exaggerate when it comes to saying they will change their allocation strategies.”
For most advisers, the move toward ETFs begins with select categories, such as large-cap-growth stocks, which often are described as the most efficient investment category.
In that respect, Mr. Smith said advisers will often opt for a broad market ETF, such as the Vanguard S&P 500 (VOO), which has an expense ratio of just 6 basis points.
“The move toward ETFs involves a little push and a little pull,” he said. “Advisers will focus on the lower cost, but because ETF investors tend to be more sophisticated, they're more interested in their portfolios and they're going to be asking more questions.”
Full portfolio transparency and lower taxes also are among the advantages that ETFs hold over traditional mutual funds, but Mr. Smith said those issues “don't get advisers as fired up.”
Among the biggest distinctions between mutual funds and ETFs is the latter's ability to trade throughout the day.
“As markets become more challenging, things like taxes and costs become more important, but there is also greater demand for and more acceptance of more-tactical strategies,” Mr. Lydon said.
jbenjamin@investmentnews.com
