“A leader is best when people barely know he exists, when his work is done, his aim fulfilled, they will say: we did it ourselves.”
Lao Tzu, 6th century BCE
It took nothing less than a global financial crisis to change the face of our industry. Necessity, the mother of invention, has led to fundamental change in the way portfolios are managed and in the solutions advisors are offering their clients.
First came the shock as traditional approaches to asset class diversification proved inadequate in the market volatility accompanying the Global Financial Crisis. Then followed investor demand for products that delivered better diversification, transparency and liquidity than what they currently owned. Witness the ETF explosion - with $2 trillion in AUM (triple that of 2008) and over 4,800 ETP offerings worldwide as of June 2013.
Sea change takes time. Professional asset managers were the first to exploit the benefits of ETFs at the fringe, primarily as short-term trading or completion vehicles. Advisors and institutional communities took much longer to assess how these vehicles could fit into their existing practices and asset allocation programs.
A sophisticated portfolio management tool
In the more than five years since the advent of the Global Financial Crisis, however, it has become clear to all parties that global investing has become considerably more complex and the goal of delivering consistent investment returns to clients much harder to achieve. In this context, the greatest benefits of the ETF emerge: as a sophisticated portfolio management tool in the hands of a professional investor.
According to recent studies by Greenwich Associates in both Canada and the United States, more than a third of Canadian institutions and half of US institutions expect to increase their allocations to ETFs by the end of 2013. Not only are there a growing number and type of institutional users, but early adopters are finding new applications of both a strategic and tactical nature within the portfolios they manage.
The ETF has made it seemingly quite simple to construct a portfolio with broad geographic, asset class and security diversification. The creation of ETF portfolios, however, requires a growing amount of research effort, a rational portfolio construction methodology, ongoing monitoring and periodic rebalancing, all of which place significant demands on the investor or advisor’s time. While ETFs now provide access to new asset types around the world, the research and due diligence required for appropriate selection has also increased exponentially.
Further, the growing complexities of global financial markets and increased macro volatility since the Global Financial Crisis have made the task of portfolio management increasingly challenging even for seasoned professionals. Those with the demonstrated knowledge and experience to build a global, multi-asset class portfolio are numbered, while the effectiveness of buy-and-hold strategies to achieve client objectives is diminished.
Tactical asset allocation strategies which pro-actively position portfolios for macro-economic events have the most opportunity to add value in this environment. ETFs are the great enabler for tactical asset allocation strategies - facilitating cost-effective asset mix shifts with greater diversification and risk management opportunities than were previously available. A disciplined and effective investment process is a must, however, for success in this arena.
The rise of the ETF strategist
In response to these challenges and to the opportunities that ETFs provide, the investment industry has witnessed over the last three years the emergence of a new category of investment manager identified as having a “special expertise and deep knowledge of ETF portfolio construction and trading,” according to a 2012 research study commissioned by BlackRock.
A number of other research organizations and industry organizations have also stepped forward to offer analysis, classifications and projections on this growing trend. The Morningstar ETF Managed Portfolios Landscape Report, published quarterly in the United States, estimates the ETF managed portfolio industry at $73 billion at March 2013 and currently tracks 605 strategies from 140 firms, mostly US- based. According to Morningstar, the segment experienced 60% growth in 2012, and another 12% growth in the first quarter of 2013, making it one of the fastest growing segments of the managed account universe.
Definitions, terminology and classification systems vary somewhat and to date, most of the industry analysis has been US-based, reflecting the leading trend in that market to provide registered investment advisors with managed ETF solutions. Efforts are underway in Canada as well, however, to identify and classify the leaders and participants in the managed ETF portfolio strategist universe.
While some asset managers resist classification and others are somewhat bemused at the flurry of recent attention in this space, for those asset managers interested in growth, the opportunity to provide ETF managed solutions to the advisor community cannot be ignored. Morningstar notes that distribution platforms in the US have begun reallocating their research resources to conduct ETF strategist research, a development industry observers in Canada are also watching. Successful ETF strategists to date have been those with at least 80% ETF content in their portfolios, offering a small number of focused portfolio strategies, and with clearly articulated client service and distribution strategies. ETF Strategists with proven track records in excess of five years should also excel in this environment. Only recently have the earliest movers in this industry begun to achieve 10-year records.
Reasons behind the ETF managed portfolio growth
There are a number of reasons for the growing use of ETF managed portfolios in the advisor channel. First, the popularity of ETFs has prompted clients to ask their advisors for ETF solutions, but many advisors do not have the time or expertise to become ETF researchers or ETF portfolio strategists. Second, increased regulatory requirements and scrutiny on advisors has led to a trend in outsourcing part or all of clients’ investment needs to third party discretionary managers able to meet the fiduciary standard.
With increased time constraints, advisors are increasingly turning to managed solutions, allowing them to spend more time with clients and focus on their practice. The growing trends toward fee-based advisory services and fee transparency also fit well with an outsourced investment management solution, allowing the advisor to charge appropriately for time spent providing other value-generating services such as financial planning.
Advisors who work with one or more ETF portfolio strategists can offer their clients the best of both worlds: top rated, institutional-quality asset management and first class service – a winning combination in any advisory practice.
Robyn Graham, Vice President/Associate Portfolio Manager, HAHN Investment Stewards firstname.lastname@example.org