How ETFs Changed The Advisory Business

A new product wrapper changed the shape of financial advice.

Reviewed by: Debbie Carlson
Edited by: Debbie Carlson

[This article appears in our February issue of ETF Report.]


Financial advisors who managed client money before 1993 had a few public options available to them: mostly mutual funds, individual stocks and individual bonds.

They left asset allocation in the hands of actively managed mutual funds, but that vehicle’s structure meant they didn’t know what they were holding real-time. Then along came the SPDR S&P 500 ETF Trust (SPY), which would radically change how advisors accessed the market, the cost they’d pay for that access, transparency, the tax efficiency and a host of other improvements over mutual funds. Fast-forward to 2019: ETFs are a $5 trillion global business.

Elisabeth Kashner, CFA, director of ETF research at FactSet, says the interest in passive investing and the efficiencies of ETFs over mutual funds have helped with their popularity.

“It’s a phenomenon I call ‘keeping your money.’ ETFs are truly a better mousetrap in terms of tightness of index tracking, tax efficiency, cost management and fairness,” she said, referring to the creation/redemption process in ETFs.

Transparency's Value
Sue Thompson, executive vice president and head of SPDR Americas Distribution at State Street Global Advisors, says ETFs’ transparency was key to advisors embracing the product. Accounting scandals with Enron and WorldCom made investors question what was in their mutual funds, she said.

“At the time [in 2002], I was working at Vanguard, and I would be talking to people, and they would say, ‘What’s my exposure?’ she said. “And we couldn’t actually [tell] with them because all you would have and all you could share was the latest quarterly holding. So advisors to some degree were flying blind. And that was tough.”

Several factors sped advisors’ ETF adoption—the internet gave people greater access to the market; stronger computing power allowed new types of risk modeling; and the dot-com bust and the 2008 credit crisis made advisors change their asset allocation models.

Matt Schiffman, principal at Broadridge Financial Solutions, called ETFs a “mostly good” disruptive force for the industry, noting a key benefit was allowing advisors to take control of the asset allocation model, which was otherwise left to mutual funds.



“They needed to be able to supplement what they’d done in the past with active mutual funds, and now take fuller control of that asset allocation,” he said. “They were able to use ETFs to slot into pieces of those portfolios and be able to offer their clients the kind of immediate liquidity and lower expenses and transparency they felt clients were looking for.”

Bob Phillips, managing principal of Spectrum Management Group, who has been a financial advisor since 1995, says he used to use mutual funds for asset allocation, but started switching to ETFs about 12 years ago for the tax efficiency, as the biggest detriment to having mutual funds held in taxable accounts was trying to avoid phantom income. Then there were the frustrations of mutual funds’ opaqueness during volatile markets of the early 2000s.

“In those bumpy markets, you had managers that you thought you understood what they owned and what their game plan was. And then they would tend to blow up in bad environments and you’d find out after the fact what caused that. With ETFs, you know what you own day by day, so you know what risk you’re taking,” he said, noting ETFs make up 50% of his business.

Exposure & Ease
Jay Batcha, founder and chief investment officer of Optimal Capital, who has been in the advisory business since 1985 and started using ETFs in the late 1990s, says at first he’d use an index-based ETF like SPY for quick stock exposure and then buy the individual stocks he wanted to own. He’d also use them (and still does) for tax-related trades, taking a tax loss on a security, but swapping into an ETF to maintain the position while waiting for the 30-day wash sale rule to pass.

Now, he says, as ETFs have become more sophisticated, he uses them for exposure to themes and factors in a low-cost, liquid way, and lets the ETF issuers do the deep research dive into the individual stocks.

“You don’t have to be an expert in biotech stocks to buy a biotech index if you like the space in general; you can take convenient exposure there,” he noted.

About half of his portfolios are in ETFs, spread between equity, fixed income and commodities.

Schiffman said passive ETFs still leave investors subject to the same beta volatility of the underlying index, so many advisors are using passive ETFs as core investments and using actively managed ETFs funds or open-end mutual funds to change the characteristics of a client’s overall portfolio.

“The beauty of these products is that it’s a kaleidoscope in terms of how you want to use them, where they go in the mix, how you want to change the risk/reward nature of the overall portfolio,” he said. “They’re an excellent vehicle to be able to do that.”

Brian Merrill, partner at Tanglewood Total Wealth Management, who has been in the business since 2000, says ETFs have made investing cheaper across the board, which helps both advisors and clients. ETFs are cheaper than mutual funds, but it’s also helped bring down the overall cost of mutual funds.

“That’s good for advisors like us that invest in ETFs and actively managed funds,” he note. “We have the benefit of the ETF investments, but also indirectly they’re helping to lower the price of our other investments.”

Rise Of Robos
With ETFs having made indexing so popular, it’s given rise to robo advisors who are building whole portfolios of balanced ETFs, providing a low-cost turnkey solution for investors who may not have an advisor. Merrill says that’s put fee pressure on advisors, and when robos debuted in 2008, they scared much of the industry into thinking it would put advisors out of business, but he doesn’t see it that way.

“If the advisor’s primary role with the client is investment selection or managing a portfolio, now they’ve got to justify why clients should pay them when they could get an ETF portfolio through one of these other firms or services,” Merrill said. “So it really makes you have to back up and support your value proposition and why you get paid and why you deserve the management fee that you get, and deliver on that.”

State Street’s Thompson says what they’re seeing now in the ETF ecosystem is that large advisors are starting to make requests for indexed products that they can add to their portfolios.

“A lot of the stuff we’ve been doing in the fourth industrial revolution … with the new funds that we’ve come out with … was largely because advisors like Ric Edelman had been talking about the fourth industrial revolution and exponential technologies, and they want products to reflect their views,” she said.

“What we do is we assess the landscape and say, well is it just him, or is this a broader trend? And if it is, then I think we, like every other ETF complex, are trying to be responsive to that advisor demand.” Thompson added.


3 Key Driver

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Debbie Carlson focuses on investing and the advisor space for U.S. News. She is an internationally published journalist with bylines in publications including Barron's, Chicago Tribune, The Guardian, Financial Advisor, ETF Report, MarketWatch, Reuters, The Wall Street Journal and others.