ETFs Grow in Appeal for Registered Investment Advisers

Advisers are increasingly embracing exchange-traded funds, but some platforms may hinder their uptake.

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Registered investment advisers (RIAs) are increasingly finding uses for exchange-traded funds, vehicles more commonly associated with the kind of rapid trading that many advisers eschew. But ETFs are already popular with some, and their uptake is only poised to increase.

An online conference, hosted by ThinkAdvisor, conducted a poll on how advisers have used ETFs. Of the participants in the survey, nearly 76 percent offered ETFs along with mutual funds and other investments, nearly 18 percent never used ETFs, and roughly 7 percent put clients in ETF-only portfolios.

Of course, survey respondents were advisers who are already using or interested in ETFs. Among the broader universe of advisers, ETFs are still used relatively infrequently, according to Paul Glenn, special counsel to the Washington-based Investment Adviser Association. “I’m not sure the typical investment adviser is using them,” he points out, “but the typical registered investment adviser firm is using them.”

One user, Jon Maier, head of ETF strategy at Merrill Lynch, says the amounts in the model portfolios he manages and on which he provides guidance to other Merrill advisers have doubled during the past 12 months. To Maier, this indicates rapidly growing acceptance of ETFs among advisers. Part of the appeal of ETFs to advisers is that the concept is easily grasped by clients, Maier says. “You have a diversified portfolio of diversified names underneath,” he explains. “I think that provides a comfort level to retail clients.”

In practical terms, ETFs give advisers ways to execute a variety of tasks. For instance, a portfolio may have a core of broad-market ETFs supplemented with market-segment or industry-sector ETFs, as well as actively traded mutual funds. The variety of available ETFs allows flexibility in managing client exposure. And their trading flexibility allows advisers to modify positions, should conditions dictate, without having to wait for the end of the day, when trades of mutual funds occur.

There are other benefits to ETFs, including low expenses, trading flexibility and high tax efficiency. And with more than $1.4 trillion under management, ETFs are well established and available for any major asset class, including stocks, bonds, currency, real estate and commodities.

Nonetheless, “ETFs still represent a tiny fraction of defined contribution assets, with $3 billion in ETF assets in a universe of $3.6 trillion,” notes Brooks Herman, head of data and research at San Diego–based financial information provider BrightScope.

One potential negative from the adviser’s standpoint is that ETFs do not offer loads or 12b-1 fees, Herman points out (which would not matter for fee-only advisers, however). Also, ETFs have not yet been taken up by defined contribution plans, including 401(k)s, which make up a significant portion of the investment universe and thus are an important market for RIAs. And in regards to trading, most 401(k) plans are set up for end-of-day net asset value pricing with mutual funds, not intraday trading, as with ETFs.

“In the large- and jumbo-plan market, there is an established investment vehicle — collective trusts — that deliver very low costs,” Herman says. “It will be difficult for ETFs to replace collective trusts in the near term in this market.” He sees ETFs making inroads in micro-to-midsize plans, however.

Another concern is that, whereas the amount of money managed in ETFs is significant, most of the assets are concentrated in a relative handful of very large funds. As a result, many of the other ETFs are small and some are thinly traded. This can make the spreads uncomfortably wide, Maier says. ETF spreads are typically less than 10 basis points, or 0.10 percent of the market price, but range from several times that for illiquid funds to as little as 1 basis point for highly liquid ETFs.

Generally speaking, ETFs seem to be meeting with some acceptance among advisers but still need some maturation before they are universally or even widely employed. “I think the ETF business is going to keep growing, although not necessarily at the pace it has been,” Maier says. “Asset managers are always looking for ways to diversify and manage expenses.”

Read more about ETFs.