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How to Pick an ETF Managed Portfolio Strategy

These vehicles are hot, but are they right for you and your clients?

Andrew Gogerty, 12/20/2012

Exchange-traded-fund managed portfolios are growing like weeds because they’re easy to use and have a low number of holdings, making them ideal candidates for unified managed accounts, portfolio overlay platforms, and traditional separate accounts. Despite their popularity, they don’t belong in every client’s account. Here’s how to decide whether ETF managed portfolios are right for clients.

1 Answer, Why Now?
You should have a clear, concise answer to this question. Your answer affects not only the rest of the decision-making process, but also the role you’ll play in managing your client’s overall financial profile. How would a move into ETF managed portfolios have an impact on your business model? What decisions are you ceding to the ETF strategist? Is your goal to generate alpha and diversify your client’s exposure within an asset class? Will you and the outside strategist each manage pieces of the asset-allocation and rebalancing decisions?

2 Understand the Portfolio Impact
The key to using a strategy well is to understand how it will be used in the client’s portfolio. Is it more of a core, diversification focused strategy, or is it a tactical, alpha-driven portfolio? What would you replace in the client’s portfolio? Does the new strategy change the portfolio’s profile? The asset allocation of many of these strategies can vary greatly in the short term, so discuss with your clients the potential for this piece of their portfolio to look different from the benchmark.

3 Caveat Emptor: Know the Details
Bear in mind that anyone can start a composite and investment strategy using ETFs, but not all strategies are credible. As it relates to performance, make sure you’re clear on these details:

Are you reviewing real or hypothetical returns? Demand that the strategists distinguish (and more importantly disclose separately) the back-tested results of their strategies from the funded composite actual returns they’ve earned while managing clients’ money. Keep in mind that no one hypes a back-tested/ hypothetical strategy that didn’t outperform.

Are the returns gross or net of fees? The profile and value proposition of the strategy could change greatly after the strategist has subtracted all fees (yours included).

Have the composite returns undergone a GIPS performance verification? The Global Investment Performance Standards are set forth by the CFA Institute for calculating composite performance. Given that these are managed accounts and not a pooled investment vehicle like a mutual fund, GIPS is the only outside verification processes available. If the firm says its composite returns are GIPS-compliant, ask to see the copy of the performance examination report for the composite of the strategy you are considering. If the strategy hasn’t complied with GIPS, you don’t need to run for the hills, but make sure that you understand what is being disclosed, how expenses are being calculated, and whether the returns are based on a model or reflect actual client accounts.

Not satisfied? Come up with your own! If you’re not happy with standard disclosures or the explanation of a firm’s process and investment strategy, create your own questionnaire for the firm to complete.

4 Communication, Communication, Communication
As the advisor, you sit between the strategist and your client, so communicating clearly with both sides is crucial. First, as the decision-maker, it’s important for you to stay on top of the strategists’ performance, due diligence, and market insights. Many of these firms began as RIAs themselves before morphing into boutique asset managers, so they know the value of communication with clients. But it’s up to you to remain current on trends and changes in portfolio strategy as a result of market conditions. Second, keep your client informed. Make sure you’re passing along not only the strategist’s perspective, but also what that investment’s allocation means in the context of the client’s portfolio.


Andrew Gogerty is the ETF managed portfolio strategist at Morningstar.

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