ETFs Change How Advisors Relate to Clients
ETFs and index mutual funds are all the rage. Credit Suisse says ETFs have gone from essentially nowhere in 2000 to about 30% of U.S. securities trading by dollar value and over 20% by share volume last year. Meanwhile financial advisors say these passive investment vehicles have also altered the way they relate to their clients, particularly around fundamentals like value and risk.
Talking to clients about ETFs is “easy because of their benefits” in pricing and transparency, says Paul Tramontozzi of KBK Wealth Management in New York.
The pricing advantages of ETFs seem clear enough. At the start of 2016, the average passive mutual fund — which, like ETFs, track indexes, sectors or themes rather than individual issues — cost 20 basis points, according to Morningstar. The average cost of an active mutual fund was four times higher.
With cost as the main consideration, 27% of retail investors who use ETFs say they account for at least a quarter of their portfolios’ value, up from 16% who said as much in 2012, according to a new report by Schwab. Another 42% say ETFs will be the main investment vehicle for their portfolios in the future. Last year, Schwab found only 28% of ETF investors saw ETFs as such a mainstay.
And ETFs have scope for continued momentum thanks to their favor among millennials. Nearly two-thirds of investors born in the 1980s and 1990s see ETFs as “the primary investment vehicle for their portfolios in the future,” according to Schwab.
Sterling Neblett of Centurion Wealth in McLean, Va., gives another reason for ETFs’ growth through the past decade. “Since 2008, ETFs have gotten a lot more robust in terms of the choices they offer investors,” he says.
In another indication of their popularity, advisors say that unlike other investment products, clients and prospects ask about ETFs by name, often with little or no prompting.
“I can be out giving planning — nothing at all on investing — and I know at some point people are going to ask about ETFs,” says Tramontozzi, an ETF arbitrage trader for 10 years before becoming an advisor in 2015. “It’s clear people want to know more about them.”
ETFs and other index-based products are also changing the way FAs relate to their clients.
For one thing, says Tramontozzi, ETFs streamline the back-and-forth with clients on investment costs and outcomes, giving him more time to focus on his clients’ “planning concerns.”
Neblett agrees. ETFs “simplify the conversation,” he says. “There’s a whole layer of discussing what active management does relative to its benchmark, and those conversations take resources and time.”
But with ETFs, “you don’t even have to go there: the index does what the index does, and an ETF will always slightly underperform” its benchmark due to internal costs, says Neblett, whose firm manages about $150 million.
“Simplicity isn’t everything though,” adds Neblett. He says he recommends ETFs to his clients where they make sense; essentially where they can capture the performance of “big indexes” cheaply. Meanwhile, he uses active vehicles for allocations around things like international and fixed income holdings.
And if chats get more complicated as a result of blending passive and active elements in a client’s portfolio, so be it, says Neblett. “The point is to do what’s best for the client, not always what’s easiest.”
Lisa Kirchenbauer, who manages about $90 million at Omega Wealth Management in Arlington, Va., also thinks “it’s important to have both ‘religions’ of investment strategy” — passive and active — “represented in our clients’ portfolios.”
On balance, she prefers ETF strategies in “longer-term-goal accounts” and in IRAs “to void potential capital gains in taxable accounts.”
Greg Gulick, an FA with Nations Advisors in Dallas, says ETFs give him an opportunity to provide “more value” to his clients — pretty much the Holy Grail for advisors these days. “There’s a lot of talk about robo advisors but we can offer more customized portfolios – often at even lower fees than robos,” he says.
This has an impact on how Gulick relates to clients, letting him focus less on the investment product elements of investing and more on “time horizons and risk tolerances.”
Where ETFs aren’t at the core of their portfolios, Gulick finds investors “overly focused on fees and less focused than they should be on risk.”