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As exchange traded funds grow in popularity, designers are devising new flavours of the investment vehicles in order to expand the marketplace.
However, rather than embracing these new offerings, the registered investment advisers (RIAs) that have been the most enthusiastic about ETFs are content to stick with the classic hits that attracted them to the products in the first place.
Passive index ETFs give investors cheap exposure to broad asset classes. They provide returns based on the performance of, say, the S&P 500 at a cost as low as a single basis point. Many investors have achieved good returns without the high fees associated with active mutual funds.
Asset managers are now launching more sophisticated ETFs that track indices based on factors other than companies’ market capitalisation.
Some advisers, though, remain cautious in their approach to such products. Herb Morgan is the chief investment officer for San Diego’s Efficient Market Advisors, a company that only uses ETFs. He puts all $4.3bn of his clients’ assets into passive index funds and is sceptical of newer types. “I have yet to see empirical data supporting alternative methods of indexing,” Mr Morgan says.
Mitch Reiner started investing in ETFs in the late 1990s at his Atlanta-based agency Capital Investment Advisors, where he is a managing partner. Nearly two decades on, “the fundamental way we use ETFs has not changed”, Mr Reiner says.
Asset managers have launched a number of novel funds in the marketplace. These include so-called smart beta offerings (which track an index constructed using factors other than market capitalisation); inverse ETFs (which generate returns when a given market’s value decreases); and active products (which have an element of active management but with a lower fee).
Fred Fern founded Los Angeles-based Churchill Management in 1963 and began investing in ETFs roughly a decade ago.
His company tries to pick the winning sector within each market cycle and uses ETFs that focus on certain themes such as technology. “I don’t like an active ETF because we want to make the management decision ourselves,” he says.
Creative Planning, an advisory firm in a suburb of Kansas City, views ETFs as a long-term holding and does not actively trade them. “If an adviser is trading them all day, which many of them do, then they aren’t really any different than someone investing and holding an active mutual fund, results-wise,” says Peter Mallouk, president at Creative Planning.
Indeed, many advisers say the draw of a simple index ETF is that it is passive. “By removing the active component, I lose the ability to beat the index, but I also lose the chance to lose against the index — which I think is more important,” Mr Morgan says.
This is not to say that advisers are putting their clients’ money into an index and twiddling their thumbs, however. Advisers can attempt to improve their clients’ returns by allocating varying amounts to different indices within a portfolio — a process Mr Morgan calls “active beta management”.
ETFs are catching up with mutual funds in the average investor’s vocabulary. “Up until 2013, 2014, we did need to explain what an ETF was,” says Marshal McReal, principal at Garde Capital in Seattle.
With large managers such as Vanguard and BlackRock’s iShares running trillions of dollars in such funds, investors’ awareness of ETFs is likely to grow further still.