Ignore ETF Strategist ‘Perfect Storm’

Reports of troubles in the world of ETF strategists are interesting, but off the mark.

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

It’s common these days in the world of ETFs to argue that the bloom is off the rose in terms of the sharp growth in the past few years in the realm of ETF strategists. But, as I’ve written here before, don’t be fooled.

Yes, Morningstar’s latest report showing a decline of assets controlled by ETF model portfolio designers is astonishing—especially considering how much ETF use is growing. Last year, a record $244 billion flowed into ETFs, and it sure looks like this year’s asset haul will be even higher.

The headline ETF strategist number of assets of $86 billion at the end of the first quarter was lower than the $103 billion at the end of the same year-earlier period. That decline is even more noteworthy considering markets were rising during the period, meaning the outflows captured in Morningstar’s survey were sizable enough to offset the rise in asset prices.

But there’s more here than meets the eye, not least that Morningstar’s report doesn’t capture all the ETF strategist assets.

Moreover, it’s easy in all the asset-tracking to lose sight of the overarching value of ETF model portfolios. They are less about chasing returns and more about providing a cheap, dependable way to outsource asset allocation to advisors keen on doing real financial planning for their clients.

The Perfect Storm

Just the same, a lot has indeed gone down in the past year that has cut asset growth in the ETF model portfolio world at the knees. But these developments involving the biggest players in the space aren’t likely to be repeated anytime soon. Consider the charges of fraud at F-Squared in the past year; the performance-related problems at Good Harbor; and finally, the departure from Windhaven Investments of its founder Stephen Cucchiaro.

Each of these totally distinct story lines—criminality at F-Squared; performance promises that couldn’t be kept at Good Harbor; and sticky assets at Windhaven that became unglued when a towering figure exited—led to outflows. And it reordered the top three ETF strategists in the space, as we reported here in May.

But the likelihood of this sort of “one, two, three” punch ever repeating is almost nil, which is why Morningstar analyst Ling Hew calls these events “the perfect storm” that’s likely to flatten the competitive landscape in a good way going forward.

The takeaway is that those wondering if the ETF strategists space is somehow stricken and now in decline are off the mark. Growth may be slowing, but it’s certainly not reversing.

You Can’t Measure What You Can’t See

Also, as noted above, there’s a lot going on that’s quite positive in the world of ETF strategists and ETF-focused asset allocation that’s hard to measure.

In other words, the Morningstar ETF strategist database, first created by Andrew Gogerty (who now works at Newfound Research) and now managed by Ling Hew, doesn’t come close to capturing the full extent of ETF model portfolios that are now part of the investment universe.

The Morningstar total is probably less than half the real number, according to Gogerty’s back-of-the-envelope calculation of all the strategies that he and his successor Ling Hew haven’t managed to aggregate in the quarterly report. Ling Hew confirms this estimate.

That means that anywhere from $175 billion to $200 billion is now in ETF model portfolios, Gogerty told ETF.com in a recent interview.

Think of all the ETF assets in wirehouses that are organized in model portfolios. Plenty of fund sponsors are getting into the ETF strategists space as well. In fact, Vanguard is one of those that reports its assets to Morningstar, though plenty, like BlackRock, don’t.

Twice As Much As You Thought

The point is this: ETFs are quickly coming to center stage and ETF model portfolios are growing as well, as more advisors begin using these types of portfolios so that they can concentrate on other aspects of financial planning or even on prospecting new business.

The Morningstar report, while valuable, is telling a tale that won’t soon repeat. More importantly, the report is likely capturing less than half the total. That means—if you believe Gogerty’s estimate of all the assets that aren’t being counted—total ETF strategist assets are really more like $200 billion, or 9 percent of the $2.114 trillion total, instead of $86 billion, or less than 5 percent of total ETF assets.

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.