US Videos

How Advisors Are Using ETFs

Jason Stipp

Paul Justice: Hi, I'm Paul Justice, Director of North American ETF Research for Morningstar. Today, I'm at the 2010 Morningstar Investment Conference, and I have the pleasure to be joined by Sue Thompson of iShares, managing director and really a champion of outreaching to investment advisors – RIAs, other financial advisors – to really promote how they can use ETFs in their portfolios.

And can you just give me a brief description of why has there been such widespread adoption by financial advisors of ETFs? And what is the real value proposition that ETFs bring to the table for them?

Sue Thompson: I think it's been – we've always seen Registered Investment Advisors be early adopters of ETFs, and the reason for that is transparency, tax efficiency, cost effectiveness. And generally, most RIAs have defined their value proposition as really providing thoughtful asset allocation to their clients and so, they've been less concerned with hitting the ball out of the park and more concerned with making sure that the portfolios are constructed.

So, you know, index type of vehicles, they've been more amenable to, and then of course with the advent of ETFs and the ability to have that transparency and the greater tax efficiency that's provided, it's been a real win for them.

Justice: Sure. You know, the fee-based advisory structure really makes a lot of sense if you are going incorporate ETFs. You don't have the incentive to go after a higher commissioned product necessarily; you are really looking out for the best interest of the client.

And how do you typically find that the advisors then go to the clients and say, here is why I think ETFs are right for you and how many ETFs or you know what portion of your portfolio could you realistically use with ETFs?

Thompson: I mean, we've seen everything from advisors that are doing 100% ETFs in portfolios to advisors that really just use them around the edges of the portfolio. Most often what we do see is using indexing at the core of the portfolio whether in equities, fixed income or both, and then using active management to supplement that core and to provide the additional alpha that they are looking for. And I think the way that they talk to their clients is really just focusing on "what are your end goals?"

And by continuing to focus on the clients' end goals, retirement, what do we need to retire, then we shouldn't take any more risks than we absolutely have to in order to get to that goal. And ETFs, they can then position as a useful risk-reduction mechanism.

Justice: Sure. And in your case – I mean, let's face it. In the U.S. market iShares is nearly half of the ETF market. If I look in Canada, it's almost 90% of the market.

These are very liquid funds, so you are not only getting the underlying exposure, but you can do some more exotic strategies around the products once they are in place. And I know that there has been a bigger push for risk reduction, say, using options around ETFs. Do you find that advisors are using that strategy as well?

Thompson: A lot of our more sophisticated wealth managers that we work with, that has been the biggest trend that I have seen since sort of 2008-2009.

And oftentimes what we'll see an advisor do is they will actually buy a put, and they'll pay for that put by writing a covered call all on the ETFs.

Justice: A straddle strategy.

Thompson: It's a straddle strategy, yeah. And what that enables them to do is, yes, it limits the upside, but it absolutely protects the client on the downside. And because, again, the client is looking at, am I going to be able to meet the retirement goal that I want? That's a really useful strategy that we've seen advisors use more and more, and of course that's one of the beauties of ETFs as differentiated from mutual funds is you do have that optionality in many ETFs.

Justice: Sure. Well, I look forward to hearing from a lot of the wonderful active managers we have at the conference here. And I am sure that you'd welcome honing some of those in your portfolio in complement with ETFs as well and some of the strategies to really reduce the risk and keep the costs down.

So Sue, thank you for joining me.

Thompson: Thank you.