Defining the needs of a client portfolio is crucial to selecting an appropriate strategy.
The growth of assets in ETF managed portfolios and the number of strategies reporting to Morningstar's separate-account database is creating a small frenzy in the managed account industry. Multiple platforms are devoting additional resources to cover these strategies. They aim to provide advisors and RIAs with better tools for understanding and adopting these strategies. Regardless of momentum, advisors' key consideration remains the same: identifying and meeting a specific need for a client portfolio. Once an advisor has identified the allocation goal, whether they're building a new portfolio or reallocating an existing one, they've created a roadmap for selecting an ETF managed-portfolio strategy.
To select a strategy and use it appropriately in a portfolio, start by answering two main questions: "What does the strategy practically do?" and "What is its potential role in a portfolio?" The answers to these questions will help advisors fit the strategy (or strategies) into a portfolio and determine the strategy's potential impact on the whole portfolio and the client's financial goals.
What Does the Strategy Practically Do?
Get down to brass tacks. Because many of the ETFs provide exposure to a basket of securities, your analysis will be more technical in nature. Look past any rhetoric (hopefully it is kept to a minimum) and identify what technical inputs are used to analyze asset classes and to select and rotate ETFs in the strategy. Many strategies look to factors such as momentum, relative value, moving average, relative volatility, mean reversion, and changes in the yield curve. Determine which levers the strategy pulls, why, and in what weight. And find out how the inputs individually add value. If the investment manager employs macro inputs, or qualitative discussion from an investment committee, learn how these aspects interact with the technical levers. Understanding the strategy from this perspective will (one hopes) confirm its stated philosophy and how the portfolio exposures are determined.
Advisors should also be clear on the strategy's tactical ability to make large reallocation moves within and between asset classes. Going in and out of asset classes and cash or staying fully invested but with large potential swings between investments doesn't change an analysis. Rather, it defines what produces the characteristics of the strategy's return stream.
Potential Role in the Portfolio = Impact on Asset Allocation
A strategy's role in a client's overall portfolio depends on three key assessments: use, purpose, and value proposition. The first two admittedly look the same, but they are materially different. Value proposition is where you press the investment manager and look for definable, quantitative support of its benefit to your client. Here is the roadmap for these considerations.
Use -- Identify the potential use of a strategy in a client portfolio. Will the strategy serve as part of the core, or will it be utilized as an alpha-generating allocation? Many global all-asset or global balanced strategies (as defined by Morningstar's ETF Managed Portfolio Attributes) are designed as a whole-portfolio solution, or an outsourced CIO offering, where the advisor allocates to a strategy and effectively removes him or herself from the asset-allocation decision-making.
Purpose -- The purpose of the strategy is to meet a return-based or holistic goal within the client's current portfolio. Here, the entire portfolio--sans the strategy under consideration--is viewed as a single entity and the new strategy is labeled by what returns or statistical metrics it can change. Will the strategy improve the entire portfolio's downside protection? Does the strategy diversify the portfolio's return stream? Improve the Sharpe or Information ratio? Dampen overall volatility? Clarity of both use and purpose give an advisor confidence on how to analyze and frame the discussion around the strategy's value proposition in a specific portfolio.