The versatility of ETFs transfers the power and control to the hands of the adviser like no other investment tool ever has.
That is why exchange traded funds are cannibalizing the mutual fund industry, as one mutual fund industry insider recently noted. The shift in assets by advisers from traditional mutual funds to ETFs is a trend that will continue and the mutual fund industry knows it.
When we look back on 2008, it will be remembered for many things, like the worldwide correction in equity and bond markets and the economic meltdown and credit tsunami that brought down some of the largest and best-known companies in the world, such as American International Group Inc. and Lehman Brothers Holding Inc., both of New York.
We witnessed a massive and unprecedented government bailout that blurred the line between the government and the private sector. The year also saw Barack Obama overcome tremendous odds to become President-elect of the United States.
Another historic change that took place in 2008 was led by investment advisers embracing a better investment tool. This year exchange traded fund became the tool of choice for millions of advisers and in the process pushed traditional mutual funds a little bit further over the cliff. All one needs to do is follow the money to see that ETFs are replacing mutual funds. According to the Washington-based Investment Company Institute, in the first nine months of 2008 equity-based mutual funds had net outflows of $124 billion. Contrast this to ETFs, which had net inflows of $104 billion over the same period.
How have ETFs gone from nonexistent to challenging traditional mutual funds for adviser dollars in just 15 years? The reason is simple: ETFs better serve the needs of advisers. There has never been an investment structure that could so easily adapt to the many different types of strategies that advisers use.
Unlike mutual funds, where the fund manager is the star and the adviser is simply the intermediary between the client and the fund, ETFs allow the adviser to step forward and be noticed. The power is in the hands of the adviser who can use ETFs to build and implement whatever strategy they feel is best for the client. In this respect, ETFs allow advisers to differentiate themselves in ways mutual funds don't.
ETFs allow advisers to be as diverse as the investing public. Whether you agree or disagree with a given strategy, there can be no doubt that ETFs provide advisers with choice. No more one-size-fits-all approach.
Buy-and-hold
Do you believe that it's difficult to beat the market? Over the long run the best approach is to build risk-adjusted portfolios that are implemented using low-cost investment vehicles. If so, ETFs are your tool. They provide low-cost, tax-efficient access to virtually every possible asset class. They allow the adviser to build the simplest to the most sophisticated buy-and-hold portfolio. Whether you rebalance quarterly, annually or not at all, ETFs are the tool to implement a low-cost buy-and-hold portfolio.
Trading
Is your business model based on trading? If so, ETFs offer easy, quick and very efficient access to entire asset classes, market segments, industry groups or a wide range of other assets. There has never been a better trading tool for advisers to use. Since they are baskets of stocks, ETFs offer a greater level of protection than trading individual stocks or options. They are easy to buy or sell by using a number of different types of orders, such as market, limit or stop orders. Whether your trading strategy is based on technical indicators or something else, ETFs are your tool.
Bearish adviser
Did you think the market was ready for a downturn in October 2007? If you did, then inverse ETFs offered you a solution. Advisers have never had such an easy way to play the short side of the market. There was a time not that long ago, when an adviser had to sell individual stocks short or buy put options in order to profit from a market selloff. These are risky strategies and can't be implemented in some accounts, such as individual retirement accounts. With inverse ETFs advisers can easily implement a wide range of strategies that will benefit if the market goes lower, in any type of account.
High risk
Do you like risk? Can you say volatility? If something doesn't move 8% to 10% in a day do to you consider it boring? If so, double ETFs are your tool. With the creation and wide-spread acceptance of double and now triple ETFs there is a trade for even the most aggressive adviser. If two times a broad-based market index isn't enough to excite you, than how about two times sector ETFs. The wide assortment of double and triple ETFs should be sufficient to keep the high-risk adviser who uses them glued to their monitor throughout the day.
Hedging
Are you just not quite sure what the market is going to do? Do you find yourself always wishing you had some level of protection for your clients? If so, inverse ETFs are perfect for you. With inverse ETFs it is easy to build sophisticated portfolios that employ different levels of hedging. ETFs give the adviser access to strategies that were once reserved for only the ultra-wealthy or large institutional investors. Best of all, with ETFs hedging strategies can be implemented at very low costs.
In my book, Strategic Index Investing (Leathers Publishing, 2005), I projected that ETFs would reach $1 trillion in assets by the end of the decade. At the time, ETFs only had about $50 billion in assets under management. Today, I'm more confident than ever that my prediction will come true. ETFs will not only hit that target but surpass it.
In this historic year of unprecedented changes, advisers are voting with their dollars and choosing ETFs.
