Mom And Pop Go Passive

November 01, 2005

Individual investors and retail financial advisors are i n c reasingly using passive investment strategies. Exchange-traded funds (ETFs) have given retail investors an easy way to access virtually any segment of the marke t with a convenient, low-cost package. At the same time, m o re bro kers and financial planners are using asset allocation plans for clients, and index funds and ETFs are the perfect solutions for implementing some (if not all) of Mom and Pop's investment plans.

The result: Passive is the place to be if you want to attract retail assets.

As seen in Figure 1, as of the end of April 2005, 13 percent of assets in long-term mutual funds and ETFs were passively invested, compared to 8 percent at the end of 2000 and just 2 percent in 1995, according to Financial Re s e a rc h Corp. (FRC ) .

Anecdotal data at financial services firms confirms the t rend. Barclays Global Investors, sponsor of iShares, saw its fund and ETF assets swell 91 percent last year to $116 billion-well ahead of all other large mutual fund complexe s on a percentage basis, according to FRC. Barclays estimates that 60 percent of net new flows are coming from re t a i l investors, and iShares ownership overall is now evenly split between institutional and retail investors-a huge change f rom 2000, when iShares were introduced and retail holders accounted for only 20 percent of assets.

M o re investment firms are offering resea rch on ETFs and tactical rotation models that their bro kers and advisors can use, says Tom Rampulla, head of intermediary sales at Vanguard. "You see lot of firms com(ing) out with ETF platforms with various allocation models," he says.

Chris Lamb, a retail bro ker with Wachovia Securities in Traverse City, Mich., is one of many bro kers increasingly using ETFs. Of $170 million in client assets, Lamb has $25 million to $30 million in ETFs, and expects the ETF share to g ro w. The products work well in implementing asset allocation plans, he says: "They've worked out great."

Ben Tobias of Tobias Financial Advisors in Plantation, Fla., now has about three-quarters of his clients' $75 million in index funds and ETFs. Five years ago that mix was a third, and ten years ago he had "next to nothing" in passive p roducts. Once a proponent of active managers, "I learned little by little that no one could beat the indexes," Tobias says, adding that he's also "been burned by various active managers."

Meanwhile, index manager Parametric Portfolio Associates of Seattle, Wash., which runs tax-managed separate accounts, has gone from $4 billion in assets at the end of 2002 to nearly $12 billion as of June 2005, says David Stein, managing director.

Greg Vigrass, head of institutional sales at FolioFN in Vienna, Va., also sees an increasing acceptance of passive a p p roaches among the advisor community. FolioFN offers diversified baskets of individual stocks, or "folios," that hold fractional shares and track various sectors or styles. The privately-held firm doesn't disclose assets, but has recently doubled the number of investment advisory firms that use its technology, from around 100 at the beginning of last year to 235 today, Vigrass says. And it has 20 bro ke r -dealers on board versus just a few at the start of 2004.

Darwin Abrahamson, CEO of Invest n Retire LLC, a Portland, Ore., 401 (k) plan provider that offers both passively-managed funds from Dimensional Fund Advisors and ETFs as investment options, agrees that the market is poised for growth. "T h e re's been an unbelievable difference in the acceptance by investors of ETFs this year compared to last year," he says, in part due to Barclays' efforts at marketing the iShares.

A year ago Invest n Retire had $1 5 million in assets; as of June 2005, that had grown to $200 million, and Abrahamson says he has many big distribution deals in the pipeline.

All of this anecdotal evidence of increasing ETF usage matches the trend in the wider market. Since the launch of the world's first ETF (the SPDRs trust, or SPY) in 1993, exponential growth in ETF assets has moved ETF inflows from a blip on the radar to an increasingly significant portion of overall mutual fund inflows, as shown in Figure 2.

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