Are Financial Advisors Lazy to Recommend Active ETFs?
There’s at least one good reason for FAs to employ actively managed funds.
Financial advisors who specialize in asset management presumably know how to build an investment portfolio. With their knowledge and skill, why would an FA need to recommend active ETFs to clients?
In other words, what value is an advisor showing if someone else is managing the clients’ assets?
There’s at least one good overriding reason for an FA to recommend actively managed exchange-traded funds, but before divulging that, allow me to fill in the back story.
When I started managing money professionally 28 years ago, active ETFs didn’t exist, but there were plenty of outstanding actively managed mutual funds.
Peter Lynch’s Fidelity Magellan fund doubled the S&P 500’s performance from 1977 to 1990. There was also Bill Miller, the legendary manager of the Legg Mason Value Trust, who outperformed the market benchmark for 15 consecutive years ending in 2005.
Today, we have thousands of actively managed funds in the form of low-cost, diversified, tax-efficient securities that trade like stocks. To be precise, there are nearly 3,400 active ETFs traded globally with over $1 trillion in assets, according to data from ETFGI.
While active ETFs are popular investment choices for retail investors, when does it make sense for FAs to hold them in client accounts?
Outsourcing: The Primary Reason for FAs to Use Active ETFs
Humility may be the most valuable virtue for a financial advisor to possess; a wise FA is aware of their human fallibility and humbly admits to not knowing everything. Thus, the number one best reason for a financial advisor to use active ETFs in client portfolios is outsourcing.
Multiple other reasons can fall under this primary heading. For example, an investment advisor that uses a core-and-satellite portfolio structure may wisely use passive ETFs for core holdings but recommend active ETFs for some of the satellites.
I humbly admit a lack of mastery of the bond market, which is much larger and more complex than the stock market. Discovering this blind spot early led me to employ the use of actively managed bond funds to complement my passive ones.
In my early days, I outsourced my fixed-income management to the old bond king, PIMCO’s Bill Gross, and the legendary Dan Fuss of Loomis Sayles.
Today, there are multiple active bond ETFs to aid in filling the fixed-income portfolio construction.
For example, an advisor may use passive ETF like the iShares Core U.S. Aggregate Bond ETF (AGG) or the Vanguard Total Bond Market Index Fund ETF (BND) as a long-term, core fixed-income holding but also recommend one or two active bond ETFs, such as the JPMorgan Ultra-Short Income ETF (JPST) or the Janus Henderson AAA CLO ETF (JAAA), for short-term tactical holdings.
The Bottom Line
In the humble opinion of this veteran advisor, good professional money managers shouldn’t need to hire other professional money managers to do their core work. However, a wise advisor will consider outsourcing some work to others who can do a better job and fill those blind spots.
The bottom line for financial advisors is to show value to the client, and picking well-managed active ETFs can be a part of that value. But if all you do is recommend active ETFs, you may eventually and justifiably be accused of being lazy.
