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Unbundling ETF Managed Portfolios

Strategies are a welcome innovation, but like all managed products, investors must approach them with care.

Jeffrey Ptak, 12/05/2012

This article originally appeared in the December/January 2013 issue of MorningstarAdvisor magazine.  To subscribe, please call 1-800-384-4000. 

Managed exchange-traded-fund portfolios, which are professionally-managed, diversified strategies that invest primarily in ETFs, have been one of the fastest-growing segments of the investment-management business in recent years. Morningstar estimates that such portfolios had $50 billion in assets under management as of June, up 30% year to date and 48% since September 2011, when Morningstar began tracking them.

What’s all the fuss about? In this commentary, we try to place managed ETF portfolios in a broader industry and historical context, attempt to explain why they’ve caught on with so many advisors, and take a stab at assessing the merits of managed ETF portfolios, including tactical strategies. (Note: We approach this topic not as totally passive observers, but as participants— Morningstar Investment Services has been managing ETF portfolios for clients since 2007.)

The New ‘New Thing’
Viewed in a certain light, managed ETF portfolios might seem radical. After all, here are portfolios that eschew the usual trappings of the investment-management business— active management, “building block” products, etc.—in taking a more-minimalist tack. With a managed ETF portfolio, it’s a manager, some index funds, and a model that brings them together in expressing a certain point of view on the markets. Where in the past the investor assembled the portfolio brick by brick, here the managed ETF strategist takes care of the whole thing.

Managed ETF portfolios also seem to break with tradition in another respect—they’re inexpensive. Whereas a typical U.S. stock mutual fund might set an investor back around 1% in annual expenses, a managed ETF portfolio might not cost more than 40 or 50 basis points in underlying fund fees, if that.

Evolution, Not Revolution
Yet, the rise of managed ETF portfolios isn’t really a signal event, but rather another fold in investment management’s evolution. Indeed, the advent of fee-based advisory, and the resulting higher demand for products like no-load funds and ETFs, came about amid a desire to separate the costs of advice, distribution, and investing itself. Thus, advisors ditched load funds and began charging a separate percentage fee for their services. Seen in that light, the move to managed ETF portfolios is just unbundling of a different sort, in this case reflecting the desire to peel the cost of pure market exposure (or beta) away from that of active management.

It also reflects the increasing primacy of asset allocation and fees. Investors singed by repeated downturns and dismayed by active managers’ inability to protect their capital have become less willing to cast their lot with a single asset class. For age and demographic reasons, many can’t afford to roll the dice and so are increasingly seeking packaged solutions that deliver exposure to many asset classes in one fell swoop, as many managed ETF portfolios do. They’re also confronting a return-constrained world in which costs loom larger, explaining the bid to wring out expenses via low-fee investment solutions.

Dollars and Sense
Managed ETF portfolios also have risen to the fore for more humdrum, though no less significant, reasons. For example, advisors who are reluctant to cut their fees have sought other ways to remove costs from the client’s experience to remain competitive; given their low associated costs, ETFs and managed ETF portfolios are a surefire way to achieve this goal.

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