Don’t Fret About ETF Strategist Slowdown

News about slowing growth of model ETF portfolios should inspire no worries given the long-term growth potential of ETFs.

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Olly
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Managing Editor
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Reviewed by: Olly Ludwig
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Edited by: Olly Ludwig



Morningstar’s year-end 2014 report on flagging growth in the world of ETF strategic might give some investors pause, but it shouldn’t.

The report showed that total assets controlled by ETF Strategists who design ETF model portfolios dipped last year to $91 billion—a 9 percent drop from the year-earlier mark of $100 billion. Such assets had made up about 6 percent of all U.S.-listed ETF assets at the end of 2013, but that percentage dropped to less than 5 percent of the total by the end of last year.

Much of that pullback has to do with challenges some of the biggest ETF Strategists are facing these days, which Morningstar said “resulted in a significant reshuffling of the landscape.”

But don’t be fooled—assets invested in ETFs jumped in 2014 by almost 18 percent to more than $2 trillion, with a good part of that growth based on record annual inflows of $242 billion, according to numbers we track at ETF.com.

Also, this area that had been generating some of the ETF industry’s strongest growth was due for a breather. Most industries grow that way—namely in spurts, punctuated by respites in growth and renewed spurts.

Still, the reshuffling Morningstar speaks of is real and it’s probably for the better. Let’s look more closely.

Trouble At The Top
At the top of the reshuffling list is the biggest ETF Strategist of all, F-Squared. The Massachusetts-based firm made headlines last year amid an investigation into whether it had misrepresented returns data.

The firm was fined by the Securities and Exchange Commission and its founder Howard Present, who resigned in the hail of scrutiny, may well face a fine himself. In all, the firm’s assets dipped by $3.3 billion in the fourth quarter—nearly all of which was due to outflows. It’s still the biggest ETF strategist, but many wonder if more outflows aren’t coming up.

Good Harbor Financial, a high-flying firm valued in recent years for its market-beating returns, saw its biggest strategy—the Good Harbor U.S. Tactical Core—end 2014 about 20 percent in the red. By comparison, the S&P 500 Index climbed 13.7 percent last year. That performance differential clearly hurt the firm. It lost $2.5 billion in assets in the fourth quarter, $2.3 billion of that in outflows.

Finally, Windhaven Investments in Boston has lost just a bit of its mojo following the resignation last year of its founder Stephen Cucchiaro. The firm suffered outflows in the fourth quarter, even though its strategies were in the black during the period.

Refocussing On What Matters

All these outflows notwithstanding, rumblings of an ETF Strategist space that has hit rocky shoals are pretty much off the mark.

Firms like F-Squared and Good Harbor got ahead of themselves in kicking sales and marketing efforts into high gear. Yes, they proved they could sell their strategies like hot cakes. But when much of the sales pitch is based on the promise of crafty quantitative and tactical asset management, it shouldn’t surprise anyone that high-flying strategies fall to Earth eventually.

I always force myself to remember the steady lessons of Standard & Poor’s SPIVA data—that most active managers aren’t able to outperform their relevant index benchmarks and, worse yet, the likelihood of underperformance among active managers becomes more pronounced over time.

In the end there are plenty of ETF Strategists who pay proper respect to the basic tenets of the efficient markets hypothesis by indexing large parts of their model ETF portfolios. Sure they may leverage the flexibility of ETFs to tilt their plans toward inflation protection, duration-targeting or offensive sector-focused choices aimed at boosting returns, but they respect what decades of research says.

For these kinds of managers who preach a sober, index-inflected investment gospel, the asset-gathering will always be a slower grind that it has been for the F-Squareds or Good Harbors of the world. That slower growth is basically an echo of how passive indexing has been embraced since it first appeared more than 40 years ago.

I’ll even go out on a limb and say that once assets move their way, such ETF Strategists who embrace “beta-plus” or “active-through-passive” ETF-based investing, those assets are likely to be sticky. As Morningstar pointed out in its report, even Vanguard is now offering ETF model portfolios via the Envestnet platform.

The way I see it, there’s no doubt that cheap, transparent and liquid ETFs are the future, just as there’s no doubt ETF Strategists have a bright future too, no matter how quickly or slowly that future reveals itself.

Olly Ludwig is the former managing editor of etf.com. Previously, he was a financial advisor at Morgan Stanley Smith Barney and an editor at Bloomberg News. Before that, Ludwig was a journalist at the Reuters News Agency in New York.

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