Your Clients Love ETFs and You Should, Too

By Brian O'Connell

A new study shows 52 percent of U.S. investors plowed cash into ETFs last year – mostly due to lower fees and more user-friendly investment structures.

Is that a problem for financial advisors, who lose some form of control, stewardship-wise, with ETFs? Not really, as the data attests.

According to BlackRock’s first-ever ETF Pulse Survey, 94 percent of U.S. money managers said they would put client money into ETFs, and 82 percent said they were doing so already.

“With one-quarter of Americans today already owning an ETF, these are clearly not niche products,” said Martin Small, head of U.S. iShares at BlackRock.

“What’s encouraging is that people who like ETFs really like them,” Small added. “These are confident investors who plan to continue to put their cash to work in the markets with ETFs, and expect to keep it there for the long term.”

Some aspects investors like about ETFs include low-cost indexing, versatility and choice, he said.

For investors and the financial advisors who act as stewards for their money, ETFs will remain a growing part of investment portfolios going forward.

“Coming off a record year where more people than ever turned to ETFs, the real opportunity now is to build on this momentum and help them understand how ETFs can enable them to become better investors over time,” Small explained.

Not Much Agreement

There are, as always, caveats with any emerging financial market trend. In this case, it’s the growing reality that money managers and clients don’t agree on a lot of issues linked to ETFs.

For example, while 64 percent of ETF-using clients see the fund category as both a long- and short-term investment option, 81 percent of advisors take the same view. (The average holding period for ETFs is five years for both groups, BlackRock reports.)

Attitudes on ETFs between clients and investment advisors differ on the following topics, as well (from the BlackRock study):

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Use of ETFs in Current Investment Portfolio % of ETF Investors % of Financial Advisors
To increase the overall diversification in my portfolio 53% 69%
For exposure to large market indices (e.g., S&P 500) 43% 79%
For exposure to a specific sector 36% 78%
As a replacement for individual stocks 42% 72%
As a replacement for mutual funds 44% 84%
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Both individuals and financial advisors rank cost benefits of ETFs highly, but differ on other top features. For example, while 30 percent of investors see “low fees” as a primary ETF benefit, 53 percent of financial advisors say the same thing.

And 23 percent of clients see ETFs as a great mechanism for portfolio diversity and risk, compared to 36 percent of money managers.

What can investment advisors do to leverage, and even capitalize, on the client trend towards using more ETFs? Knowing how to push the right buttons is a good head start, financial experts say.

“The trend toward ETF investing will increase returns for active managers as the spread between the intrinsic value and market value of securities widens. Thus, there will be less active managers seeking abnormal returns, thus more opportunities for those that are consistent stock pickers,” explained Daniel Lugasi, a portfolio manager at VL Capital Management, in Orlando, Fla.

How advisors trade in the ETF market matters, too.

“As long as you stay away from ETFs that are thinly traded, you’re going to be in pretty good shape using ETFs over their higher cost, slightly less liquid counterpart, mutual funds,” said Kyle J. McCauley, managing partner at City Center Financial.

However, there is an important distinction to make.

"Mutual funds are only less liquid if the ETF being used is actively traded. Otherwise, a thin-market ETF could end up causing an investor to lose a fair amount of money due to the spread on the bid/ask price on the ETF,” McCauley added.

Active Strategy

One way that McCauley’s firm uses ETFs for its clients is within an actively managed strategy.

“By using actively traded sector ETFs, we gain the ability to sell ETFs at any point throughout the trading day,” he said. “That provides extra liquidity and nimbleness to avoid troubled market sectors, and take advantage of market sectors that poised to do well.”

Others caution that it’s risky to call ETFs a good opportunity, even as the fund category hits a higher gear.

“The vehicle is not the opportunity, the part of the market that that particular ETF is choosing to focus on may be the opportunity,” said Norman M. Boone, founder and president at Mosaic Financial Partners in San Francisco.

That said, Boone does view ETFs as being “tax efficient” and being “easy to buy and sell.”

“You can also buy them at any time during the day, whereas mutual funds are priced and officially purchased at the end of the day, after the close of the market,” he said. “For those into trading on the ‘good idea of the day’ this makes ETFs attractive trading vehicles.”

For financial advisors, the second decade of the 21st century may well go down, Wall Street-wise, as the age of the ETF. As soon as they get on the same page on ETFs as their clients, those money managers may really start benefiting from these low-cost funds.

But in their client minds, apparently, the sooner that happens, the better.

Brian O'Connell is a former Wall Street bond trader, and author of the best-selling books, The 401k Millionaire and CNBC's Guide to Creating Wealth. He's a regular contributor to major media business platforms, including CBS News, The Street.com, and Bloomberg. Brian may be contacted at [email protected].