An emerging market of strategies takes advantage of advisors’ growing interest in funds of funds.
This article originally appeared in the December/January 2013 issue of MorningstarAdvisor magazine. To subscribe, please call 1-800-384-4000.
While the popularity of exchange-traded funds among financial advisors and other institutional users is no longer a new story, the emerging story of ETF managed portfolios has been little discussed. Their growth illustrates the massive appeal that funds of funds have for advisors in today’s investing environment. Primarily structured as separate accounts, these strategies typically have more than 50% of portfolio assets invested in ETFs and represent one of the fastest-growing segments of the managed-account universe.
Professional money managers are packaging portfolios of ETFs into investment strategies to meet a wide array of investor demands. The influx of new individual ETFs provides access to stand-alone investment strategies and one-stop, complete-solution offerings.
Morningstar tracks nearly 490 strategies from 120 firms with assets of $50 billion as of June. Assets in this space grew 30% in the first six months of 2012 and 48% since September 2011. These numbers mark a significant increase from the 370 strategies offered by 95 firms that contributed to Morningstar’s database a year earlier. Demand for access to and information on ETF managed portfolios is on the rise, coming from both the firms managing these portfolios and the institutional decision-makers responsible for including them on advisors’ distribution platforms.
An Evolution of Money Management
The market for ETF managed portfolios is growing for several reasons. Morningstar and academic research have shown that asset allocation is as important as security selection in determining a portfolio’s total return. A prudently constructed portfolio of ETFs provides wide asset-allocation options and low-cost diversification. ETFs provide transparency, intraday liquidity, and portfolio consistency to strategists allocating among various asset classes and subclasses.
The fiduciary standard continues to move forward as the baseline philosophy for managing client portfolios. As a result, more fee-based advisors are tilting clients’ portfolios toward lower-cost, broad-based investments, with a focus on asset allocation. In addition, the ETF as a technology platform allows third-party ETF strategists to deliver to advisors institutional-type diversification and portfolio management, allowing advisors to focus on gathering and retaining client assets and managing clients’ overall financial profiles.
The New Crop of Asset Managers
The growing use of ETF managed portfolios has led to changes in how ETF strategist firms are organized and perceived by advisors and institutional decision-makers. Many of these firms were started by financial advisors who broke away from wirehouse operations or other regional broker/dealers. As is the case with many startup ventures, these entrepreneurs were likely lured by the possibility of greater autonomy, a wider potential client base, and the ability to build a distinct brand.