[This article originally appeared in our July issue of ETF Report.]
Behind the more than $2 trillion now invested in exchange-traded funds are advisors who, for various reasons, decided it was time to strike out on their own and put ETFs at the center of their money management businesses.
Their motivations for breaking away vary, from a disenchantment with various aspects of the old ways to an unequivocal insight that the ETF is the only sensible way to build a cutting-edge 21st-century advisory business.
What unites them all is a view that cheap, transparent and tradable ETFs canvassing swaths of the investment universe broad and narrow opened up new possibilities of accessing a multitude of asset classes—and outperforming—with index ETFs. Who needs to pick stocks, use Morningstar "Style Boxes" or even use active mutual funds in 401(k)s when it can all done with ETFs?, the pioneers asked.
Lonely Early Days
"If you have high ethics and you know something is not the right way to do things for clients, then everything else doesn't make sense—you don't sleep well at night," said Tyler Mordy, president and co-chief investment officer at Toronto-based Hahn Investment Stewards. He says that many big banks notoriously charge clients too much, have inferior outcomes and, worse, are "calcified" in their ways.
"We felt like we were a rock band touring for 10 years in dingy bars and pubs. We were not an overnight success. There were some lonely, lonely days," said Mordy, who joined his partner Wilfred Hahn in 2001, as he says, "in the ashes of the dot-com bust."
The idea of finding opportunity and of new ideas getting traction in the wake of crisis is as old as capitalism itself and, true to form, the ETF revolution has manifested in waves, each seemingly prompted by an economic downturn.
The first exchange-traded fund, the SPDR S&P 500 ETF (SPY | A-98), launched in January 1993 at the end of the lengthy post-1980s downturn. The ETF truly came of age in the wreckage of the subprime mortgage crisis of 2007-2009. Indeed, most entrepreneurs who have started an advisory firm during or since the market crash of 2008-2009 have chosen to use ETFs pretty much as a matter of course.
First Rumblings Of Change
Plenty of ETF advisors say that they were early adopters of ETFs. But David Kotok, chairman and chief investment officer of Sarasota, Florida-based Cumberland Advisors, has one of the more plausible claims. Kotok's tale takes us to the glory days of the dot-com bubble and to the heart of what is so powerful about ETFs.
"When you think of the history of ETFs, the first one was in '93, the second one was '95," said Kotok, laying out the fact that the lack of funds in the early days precluded anything like thoughtful asset allocation.
"In 1999, we had a problem because the tech-sector weight was huge, and people had this idea that if they owned Microsoft and Applied Materials and Cisco, they had a diversified portfolio," he said, remembering that the combined market value of Microsoft and Cisco of $1 trillion at that time was 1/30th of the market value of all stock markets on Earth.
"The sectors SPDRs [launched in 1998] provided us a way to get into the rest of the world without the tech sector being so heavy. The need to reduce tech-stock exposure in 1999 drove us to a separately managed account using ETFs only," Kotok noted.
Kotok says the more enduring insight culled from the tech bubble was that there was really only so much that investors can learn about single stocks without wasting precious time and effort and even running afoul of securities laws to get an edge.
"ETFs enable me to use valuation techniques, economic techniques, sector analysis—broader themes," Kotok said. "With ETFs, I don't have to try to find a piece of information that somebody else doesn't have. That reality hit us in 1999 when we started to use ETFs, which is why we persisted."