Inside ETFs: A Reality Check
February 10, 2012
The Inside ETFs conference last month was a great opportunity for an ETF analyst like me to escape my ivory tower.
Yes, I got to doff my pointy-headed cap and listen to the day-to-day challenges and opportunities that ETFs present to the advisors who use them.
It got me thinking in fresh ways.
It’s All Relative
Right off the bat, I spoke with one advisor about two competing ETFs, sharing my keen insight about how fund “A” had roughly double the fees of fund “B,” and why this was hard to justify, given their similarities.
The advisor politely nodded and reminded me that even the more expensive ETF was still quite a bit cheaper than competing mutual funds. The advisor’s point simply conveyed that the original attraction to ETFs over mutual funds on the basis of fees remains strong.
The extension to this argument is that slight differences in cost shouldn’t be the sole driver of ETF selection for many investors.
For example, some U.S. equity sector ETF issuers are fighting a price war, undercutting each other by a basis point.
But even the most plain-vanilla funds have some difference—whether trading costs, portfolio exposure or performance history—that really should be a lot more important to investors than a 0.01 percent disparity in annual cost.
Needs Improvement: Works Well With Others
Advisors, like the one above, showed up in record numbers to this latest conference, underscoring how ETFs continue to be a major growth engine in the money management industry.
But even as the ETF industry lurches forward with more products, more assets under management and downward pressures on fees, some basic challenges remain unaddressed.
The most common complaint I heard wasn’t about the funds themselves, but instead about how difficult it can be for advisors to display aggregate portfolio positions to their clients.
Advisors need to provide a simple pie-chart position statement to each client that shows their net asset allocation: “x percent” domestic equity, “y percent” international equity and “z percent” bonds, etc.
But when a client owns a mix of ETFs along with individual stocks and bonds, the ETF ticker often gets reported as a domestic equity in the asset class breakdown. With the hundreds of bond, commodity and currency ETFs on the market—to say nothing of funds with mixed assets, reporting each ETF as an equity to the client will be wrong in many cases.
The challenge grows harder when an advisor wins new business and needs to take measure of the new client’s portfolio—a task that might well involve poring through lists of unfamiliar tickers all reported as “equity.”
I’m no expert on the reporting function in portfolio management software. My only point here is to give voice to the most common complaint that I heard at our conference in Florida. I found it interesting simply because I spend so much time diving deeply in the ETF world, so I need to be reminded of the working reality of holding ETFs in an everyday portfolio.
The Universe Is Expanding
As I headed from a panel on VIX-based funds to a panel on inflation, a VIX panelist wondered aloud whether there was any inflation to worry about. His point was that while volatility ETFs were incredibly relevant in 2011, domestic inflation seems like a nonissue in the short run.
As it turned out, the inflation panel was well attended.
The beauty of the expanding world of ETF choices is that those with differing views have powerful tools at hand.
Volatility funds abound, with front-month, midterm, levered and inverse exposures to choose from. In the same vein, investors worried about inflation can fight it using TIPS, commodities or real estate funds, or with funds that explicitly target inflation.
The point is that investors and advisors have an ever-increasing toolbox to execute tactics and strategies consistent with their worldview and their needs. This ETF toolbox expands the opportunity set, and makes the efficient frontier more pliable for investors of all stripes.
But, unlike the children in Lake Wobegon, most funds are not above average, whether in value or performance.
Now that I’m back in my ivory tower, I realize more than ever that the growing ETF options in the market don’t automatically translate into advisors knowing what’s at their disposal or what exactly to do with the new products.
So here’s to being more clear and more direct, even as the world of ETFs grows bigger and more complex.