Investing Insights: How iSectors Utilizes ETFs

by on March 20, 2014

While countless individual investors have embraced ETFs for their ease-of-use, cost-efficiency, and unparalleled transparency, a growing number of institutional investors are also taking advantage of the exchange-traded product structure. iSectors, an investment strategist focused on creating ETF-based allocation models for other advisors, has been utilizing ETFs for almost a decade now, since February of 2005. The firm’s founder and CEO, Vern Sumnicht, recently took time to explain the role that ETFs play at his firm and what the industry’s future may have in store [see also 7 Charts to Put the ETF Industry in Perspective].

ETF Database (ETFdb): What exactly is iSectors? 

Vern Sumnicht (VS): iSectors is an investment strategist that specializes in ETF based asset allocation models. iSectors allocation models are available exclusively to investment advisors through turn-key asset management platforms (TAMP).  The efficiency gained by outsourcing investment management services through a TAMP and using iSectors allocation models, allows investment advisors to reduce cost, improve performance and save time. In addition to enhancing client satisfaction, this affords the advisors more time to service their clients and develop new client relationships.

iSectors offers a suite of 15 ETF-based asset allocation models, using one or more iSectors models an advisor can build a portfolio that is tailored to the client’s specific risk/return objective(s). Through the use of TAMPs and iSectors ETF models, clients receive daily pricing, daily liquidity, holdings transparency and reduced expenses.

Through the TAMP using iSectors asset allocation models, clients own separately managed accounts (SMAs) or unified managed accounts (UMAs). Accounts can be established for taxable, non-taxable, including 401(k) and other retirement plans. For 401(k) plans, the iSectors allocations are accessed through Mid-Atlantic Capital Group’s ModelxChange platform. iSectors can partner with various TPAs, record keepers and other providers to develop open-source retirement plans customized to meet the specific needs of your plan.

ETFdb: What was the inspiration behind it?

VS: Sumnicht & Associates LLC was founded in 1988.  For most of that time, we were committed to active asset management.  That is, I believed well selected managers could outperform their benchmark indexes.  However, as the markets began to peak in 1988 and 1989, we fell into a prolonged bear market.  My dissatisfaction to professional money managers and managed mutual funds grew to the point where I knew we needed to change.  It became obvious that indexing or passive asset management with its lower expenses provided better returns for clients than paying for active asset management.

It took our team 5 years to research the subject, but eventually we developed a number of passive asset allocation models using exchange-traded funds (ETFs).  After employing my own investments to these allocation models and then moving my clients to them, I realized that other managers would also find this approach valuable for their clients.  This is when I decided to form iSectors and develop a team to help other advisors do the same thing for their clients that I had found so helpful for mine.

ETFdb: How long have you been using ETFs?

VS: Our flagship model, the first model we developed, using a passive ETF-based approach was iSectors Post-MPT Growth Allocation, which began investing client assets on February 1, 2005.  The objective of iSectors Post-MPT Growth Allocation is to achieve investment returns that outperform the S&P 500 stock market index with lower downside risk over a complete market cycle.  The investment model optimizes the portfolio allocation among up to nine specific, low-correlated asset classes.  The mathematical process used to determine the optimal asset allocation includes over a dozen economic and capital market factors.  Client accounts are separately managed and offer daily liquidity. Securities holdings, performance and tax information, with prices updated as of the previous day’s close, can be viewed online [see our 50+ All-ETF Model Portfolios].

ETFdb: Do you see this product structure as the preferred means for building diversified, low-cost, long-term portfolios?

VS: We did a lot of research and thought long and hard about finding an alternative to professional managers and managed mutual funds.  It became apparent that if we were going to do the best we could for our clients, we needed to change to a passive ETF-based approach.  As Warren Buffett once said, “Should you find yourself in a chronically leaking boat, energy to changing leaking vessels is likely to be more productive than energy devoted to patching leaks.”  The expenses leaking from client portfolios using active management and mutual funds was obviously sinking our clients’ boats.  After 9 years of results, I am confident that our passive ETF-based asset allocation approach is the preferred means to building diversified, low-cost portfolios.  Over the long term, iSectors asset allocation models are proving to be substantially better vessels for carrying client portfolios.

ETFdb: Why do you think many financial advisors have generally been slow to embrace ETFs in their practice?

VS: I think financial advisors can become somewhat complacent in the policies and procedures they use to manage client portfolios.  To a certain extent, they have their egos invested in how they manage clients’ money, inertia takes over and it’s difficult to change.   Admitting that you may not be doing things as well as you could; can also make it difficult to change.  Although it’s difficult, change is necessary to grow any business. Advisors need to continuously change to take advantage of efficiencies created by improving technology.  If we don’t change, our competitors will be “eating our lunch”, so to speak.  Our industry faces constant fee compression by using technological efficiencies, outsourcing, and learning to live with change keeps us competitive and allows us to better serve our clients as we grow our businesses [see 25 Things Every Financial Advisor Should Know About ETFs].

ETFdb: Are there asset classes where you’re more comfortable using ETFs and others where you prefer mutual funds or other vehicles?

VS: There are a couple of asset classes where ETFs are not available or efficient.  For example, in the area of commodities, most diversified commodity portfolios are structured as exchange-traded notes (ETNs), which have additional third-party risk in the banks holding the ETNs.  In this case, it may be more efficient to look for a mutual fund.  Another example is in the area of hedge-fund strategies.  Certain hedge-fund strategies are not available in the ETF structure, in which case, a mutual fund may be preferred if you are looking to place certain hedge-fund strategies in your portfolio.

ETFdb: How are your strategies evolving in the current environment?

VS: We have not seen any strategies, per se, evolving; however, as the economic situation changes, we do see investors moving money out of certain strategies and into other strategies.  For example, the more the Federal Reserve talks about tapering, investors fear rising interest rates and are moving their portfolios from longer-term bond funds to short-term bond funds.  With the emerging markets underperforming in 2013, we saw movement from global allocation portfolios to domestic allocation portfolios.  We’ve also noticed when fears of inflation begin to rear their ugly heads; investors increase their allocations to precious metals as an inflation hedge.

The Bottom Line

In addition to individual investors benefiting from the proliferation of ETFs and the democratization of asset classes that they have brought, institutional money managers have also embraced these financial instruments for many good reasons. Whether you are managing a client’s or your own portfolio, ETFs warrant a closer look from anyone looking to minimize investing costs and improve allocation efficiency over the long-haul.

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Disclosure: No positions at time of writing.