The Trump reflation trade may have extended the lifeline on U.S. and global equities, but there’s no denying that we are embarking on a period of profound, unpredictable change. With very few places to turn, investors are relying more on ETF-managed portfolios to hedge against risks and provide much-needed stability. At the core of this strategy is the desire to outperform the market.
Against this backdrop, ETF-managed portfolios have emerged as one of the fastest-growing segments of the managed account industry. Put simply, an ETF portfolio is considered “managed” if it invests more than 50% of its assets in exchange-traded funds on the basis of a specific investment strategy and risk tolerance. Typically, these strategies combine the efficiencies and diversification benefits of ETFs with a professionally managed portfolio.
The market for managed ETFs has exploded in recent years, with total assets under management exceeding $87 billion in the third quarter of 2016. By the first quarter of 2017, that figure had surged to nearly $100 billion, with Vanguard, RiverFront, State Street and BlackRock adding a combined $2.3 billion.
ETF-managed portfolios have numerous benefits, such as delivering institutional-quality investments in a format that is easily accessible to modern investors. These portfolios are better able to match an investor’s personal goals, risk tolerance and time horizons. Portfolio managers can also use this time to learn more about their clients, which will help them deliver a strategy more in tune with their needs. Most importantly, professionally managed ETFs provide broad exposure to the financial markets without compromising agility. After all, the presence of an advisor means allocations can be adjusted as needed.
Of course, one of the most notable disadvantages of managed portfolios is the higher costs associated with them. They may also not be ideal for investors who do not like to relinquish control of their portfolios.
For advisors, ETF-managed portfolios help them better manage risk in their clients’ portfolios by hedging against large market declines. This can be done through long-term put options or selecting low-cost ETFs to reduce or eliminate individual stock picks and sector rotation. ETFs are also effective for tax harvesting because they generally create fewer taxable events than mutual funds. The wide selection of ETFs on the market also gives advisors more flexibility in optimizing their clients’ goals. Because these funds are actively managed, they can be amended as needed to account for new information or changes in market dynamics.
Actively managed funds are continuing to lure more capital from traditional mutual funds as advisors and institutional investors search for higher yield. Although the actively managed component of the ETF universe is very small relative to the whole, it continues to grow due to inherent cost savings and an uncertain investing climate. Although 2017 has been overwhelmingly positive, the immediate future looks much more bleak.
According to a recent study by Vanguard, the chance of a U.S. stock market correction now sits at 70%. What’s more, returns over the next five years are expected to be no better than 4% to 6%. Clearly, many people are of the opinion that the current market is overvalued or, at the very least, overstretched. This makes managed ETFs a smart option for advisors and investors in search of a more active hedge against risk.
The Bottom Line
The growth of ETF-managed portfolios is unlikely to be upended anytime soon. As more investors look to outperform the market, a managed approach will likely proliferate for years to come.