Some financial advisers are using exchange traded funds (ETFs) heavily in client portfolios, drawn to the low-cost structure, intraday trading and tax benefits.

In fact, 16.5 per cent, or 66 of the top 400 advisers surveyed by the Financial Times, allocate 20 per cent or more of their overall assets under management (AUM) to ETFs.

ETFs are funds that trade on an exchange, like a stock, and fluctuate in price throughout the day. They may hold assets including stocks, bonds and commodities and often track an index.

Ron Vinder, an adviser at UBS Financial Services who reported $919m in AUM last year, says his team relies exclusively on ETFs to build asset allocation models for clients, targeting returns that keep up with market averages.

“We find that ETFs give us the lowest cost, most tax-efficient way to obtain those target returns,” Mr Vinder says.

Investing in an ETF offers greater diversification and often less risk than choosing an individual stock, advisers say. Many also cite low costs, relative to active mutual funds, as a key factor driving them to ETFs.

Craig Pastolove, an adviser at Morgan Stanley, used to rely on third-party active managers to run client portfolios, but found that high fees were eating away at client returns. About six years ago, he tried a different approach, drawing on ETFs and other index-based funds for the bulk of equity portfolios.

“I wound up getting tired of paying managers’ fees in very efficient asset classes,” Mr Pastolove says. “Now that we are able to use ETFs, the costs have come down significantly.”

Mr Pastolove now builds portfolios using a core-satellite approach, using ETFs for what he views as efficient asset classes, and turning to active strategies when he spots an opportunity to beat the benchmark. He uses ETFs for about 60 per cent of client assets. Overall, he had $513m in AUM in 2013.

ETFs also have tax loss-harvesting benefits, says Mr Pastolove. For example, when an ETF declines in value, he can sell, reinvest the money in a similar fund and the client can declare a tax loss. He also allocates to mutual funds, separately managed accounts and alternatives for portions of client portfolios, according to the survey.

“ETFs are really not appropriate in every asset class,” he says. “Just because they’re available doesn’t mean it makes sense to be there.”

Charles Zhang, an adviser with Zhang Financial, which has about $589m in AUM, turns to ETFs to take advantage of intraday trading and limit orders.

Zhang Financial is a fee-only firm that works with LPL Financial and TD Ameritrade for custody. ETFs made up about 30 per cent of Mr Zhang’s AUM, according to the survey.

While Mr Zhang invests a portion of a client’s equity allocation in mutual funds, he usually sets aside about a third of those assets to set up limit orders for ETFs. By doing this, he aims to benefit from market corrections or intraday price declines.

“We try to take advantage of the market movements and make sure clients get a better deal,” he says. “When you set up a limit order, you take the noise away, so you become more disciplined.”

When using ETFs, investors should keep in mind liquidity and bid-ask spreads, says Mr Zhang. He suggests turning to the biggest sponsors and well-established funds.

“If a certain ETF has a huge spread, when you buy and sell, you could be losing a lot,” he says.

Daniel Schwartz, an adviser at UBS Private Wealth Management with about $723m in AUM in 2013, uses ETFs to build about three quarters of the discretionary model portfolios his team creates for clients. The rest he allocates to individual stocks, aiming to beat the market.

“ETFs are transparent and you do get that precise exposure,” he says.

He looks for ETFs that have little or no tracking error relative to their benchmark index.

Mr Schwartz also warned investors to stay away from leveraged ETFs, which rebalance daily and aim to deliver multiples of market returns, but can be particularly volatile.

At the end of the day, due diligence on ETFs is critical, Mr Vinder says. “All ETFs are not created equal. Make sure you know what you are getting into.”

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