ETF Model Portfolios Change Advisory Biz

June 27, 2014

ETF portfolio due diligence expert says advisors are increasingly embracing model portfolios comprising ETFs.

Advisors face a great challenge today, and that is determining which ETF model portfolio is right for their clients. As an industry, the ETF strategist space lacks standardization in terms of nomenclature—a so-called global tactical portfolio might not mean the same type of exposure to different strategists—as well as any sort of rating system that allows you to compare and contrast similar model portfolios from different providers.

That’s what Envestnet sets out to do. The firm combs through the various portfolios in an extensive due diligence process that looks to shed light in the murky space. In the end, advisors are offered a platform of pre-screened model portfolios that have been scored for risk, among other things. Brooks Friederich, director of fund strategist portfolios for Envestnet, is driving this effort, and he shared with some of his insights on the space, as well as the building blocks advisors are clamoring for these days. As an advisor, how do you begin the process of selecting an ETF portfolio from various ETF strategists? There’s no standardization in this space—what one strategist might consider a global tactical portfolio can be completely different from what another one calls it. How does an advisor start this process?

Brooks Friederich: We first have them fill out a traditional due diligence questionnaire with questions like, Can you use ETFs? What types? Can you use leverage or inverse ETFs? Do you prefer a specific ETF provider? And other questions like that.

We also have a risk score questionnaire to determine the flexibility around asset allocation in these portfolios, and that helps us, from a data standpoint, understand how flexible they can be.

We look at historical trades, and look at a qualitative assessment from the analysts—things like, “I know who these guys are. I know this model”—the human element of these strategies, if you will, so it’s not just purely data driven. We put all of these pieces together to give it an overall encompassing risk score.

In the end, the risk-score process helps categorize these strategists’ portfolios into certain risk profiles. And that helps advisors. But to your point about the qualitative aspect of things—things like naming convention—it’s becoming more of a marketing and sales gimmick sometimes.

“Tactical” means different things to different managers. And there's nothing wrong with them. But we have to take our stance and say, “Here is our definition of tactical,” which is simplistically just unconstrained: the flexibility to go 100 percent cash to 100 percent equity.

If you have that in your mandate, you get put in the tactical bucket. If you have to have certain guidelines like minimum and maximums—say, 50 percent equity and 50 percent bond—that’s going to be a different risk profile. We model that out and incorporate your historical allocations to differentiate them based on risk.

It’s a helpful process, because people were just lumping together all global tactical guys into one group, and looking at a 2008 performance number, and saying, “Well this guy was up similar to that guy.” Now, going forward, they’re more likely to differentiate.



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