Practical guidelines start with asking the right questions, not the easy ones.
Advisors and registered investment advisors continue to embrace ETF managed portfolios within managed accounts. These strategies typically invest more than 50% of the portfolio in exchange-traded funds, and many use active allocation. As of the end of 2012, Morningstar tracked $63 billion in assets from 530 different strategies. Collective assets grew 60% last year thanks to increased demand and distribution into the advisor and broker/dealer communities. As more investors consider ETF managed portfolios, there’s more need to define terms such as “global tactical asset allocation” and “ETF strategist,” as well as develop standards for selecting strategies for client portfolios.
Don’t waste time trying to decipher the nomenclatures for firms; they’re largely irrelevant. Paying attention to what a portfolio does over time is more important than understanding the way the industry has labeled the firms or even the strategies offered.
Advisors and other gatekeepers can evaluate the firms offering the strategies as they would any traditional boutique asset manager. For example, Sage Advisory is one of the most prominent firms in the ETF managed portfolio universe. But calling the firm an “ETF strategist” is too narrow. The firm offers a target-date series (utilizing ETFs), a series of stand-alone ETF managed portfolios, as well as a suite of traditional institutional fixed-income strategies. Both asset managers and their ETF managed portfolio strategies should be held to the same standards of research, analysis, and selection as traditional separate-account managers and investment products.
To evaluate a firm’s portfolios, look inside and answer two main questions: “What does the strategy practically do?” and “What is its potential role in a portfolio?” These answers will clarify the value proposition of a particular strategy. It’s important to study how a strategy has evolved and determine whether it’s a total portfolio solution or whether it includes tactical changes. For example, if a strategy says its aim is “global tactical asset allocation,” then determine where in the globe it’s investing, what types of assets it holds, and how often it makes changes to country, sector, and asset-class weights. After a pragmatic, systematic study, you should be able to answer the most important question: “Does this strategy effectively meet the client’s goal?”
In this series, we’ll outline a set of considerations for evaluating the key aspects of an ETF managed portfolio strategy. The series will focus on the following topics:
Additional research will focus on topics such as proper benchmark construction, performance analysis, and trading and execution developments.
All sound research processes start with a look in the mirror. Ask yourself, “Why am I adding an ETF managed portfolio to my client’s account, and why now?” ETF managed portfolios don’t belong in every client account. These strategies, with their potentially low relative number of holdings, makes them strong candidates for pairing inside a unified managed account or portfolio overlay platform, but the same could be said for a do-it-yourself portfolio constructed with a small handful of broad-based ETFs. These technology platforms are an efficient means of delivering portfolio strategies and lend themselves to ETFs and other exchange-traded vehicles, but they have some potential drawbacks.
Know Your Role
Outsourcing part or all of a client portfolio’s asset-allocation decisions is a material change to the advisor-client relationship. As a result, the advisor must understand and communicate this change to clients in the context of the entire financial-planning process. Informed and engaged clients will want to know how the advisor’s role compares with the role of the new asset manager, and how they’ll learn about changes in the portfolio. Key questions for advisors to consider include:
Understand the Change in Economics
After assessing the client impact, an advisor must take a look at his or her practice’s business model. Client advisory is a business, and businesses are built on economics. Compensation structures often drive the focus of an advisory practice. Advisors doing all of the asset allocation, investment product research, and trading would command a certain compensation, while other advisory practices centered on gathering and retaining client assets and managing a client’s overall financial profile could be at a different level. We’re not saying that there has to be or even would be a change in compensation. But if a firm is comfortable ceding more of the actual portfolio management duties to strategist firms, it should consider what, if any, changes in economics may occur between the advisor and asset manager. Can the advisor deliver the same level of service, advice, and consultation to the client under any potential new arrangement?
You Are Still the Portfolio Manager
Lastly, but far from least important, remember that the advisor remains the key portfolio manager to the client. The advisor may allocate the entire portfolio to one or more ETF managed portfolio strategies, thus outsourcing decisions such as when to tactically move from a U.S.-equity ETF to one focused on emerging-markets bonds, but the advisor remains the key decision-maker and manager of the following aspects of a client portfolio:
Understanding ETF managed portfolios’ roles and goals increases the likelihood that advisors choose the proper strategies and meet their clients’ financial goals.
For the newly initiated to ETF managed portfolios, the latest Morningstar ETF Managed Portfolios Landscape Report can be found here. The report is a comprehensive industry review of strategies that report information to Morningstar’s separate-account database. Further strategy and firm information can be found in the ETF managed portfolio screener within the ETF Managed Portfolio Center. Registered users can utilize this proprietary screener to focus their search on one or more potential ETF strategists and portfolios. More in-depth and custom research and analytic tools are available within the separate-account database in Morningstar’s other research platforms (Direct, Office, and Workstation).