Advisor Insights: Embracing ETF Flexibility
Thu, Nov 1, 9:15 AM ET, by Michael Johnston
ETFs continue to find their way into countless portfolios as investors of all walks and styles have embraced these financial building blocks as part of their long-term strategy. Although many professional money managers have been hesitant to jump into the exchange-traded universe, those that have made the switch continue to reap the benefits offered through these innovative investment vehicles. J.J. Schenkelberg, CFA and Senior Portfolio Manager at CLS Investments, recently took time to share her experience with ETFs and also offer insights as to how her firm has been able to successfully utilize the growing lineup of funds [see How To Pick The Right ETF Every Time].
ETF Database (ETFdb): How long have you been using ETFs for? Do you see this product structure as the preferred means for building diversified, low-cost, long-term portfolios?
J.J. Schenkelberg (JJ): CLS Investments, LLC has a composite track record with ETF separate account portfolios dating back to April 2001. Prior to that time, CLS explored the use of ETFs within our family of proprietary mutual funds, which are structured as funds of funds. We are one of the longest-term users of ETFs and listed in the top 10 users of ETFs according to BlackRock/iShares. Our proprietary mutual funds were originally structured as funds of actively managed mutual funds, since our portfolio managers identified that CLS's primary expertise was in the allocation of the overall portfolio and choosing what part of the investment universe to underweight or overweight.
In other words, the portfolio managers found they could bring more value to the portfolio by choosing to own small cap equities rather than choosing specifically which small cap equity manager to use. As our funds grew, it also became more difficult to actively trade the active fund managers. ETFs were a natural solution versus actively managed mutual funds because they offer lower cost, flexible market exposure that is not subject to style drift. As the ETF industry grew, we found more opportunities to utilize ETFs for total market exposure and build separate account portfolios. We certainly believe this product structure is the preferred means for building diversified, low-cost, long-term portfolios.
ETFdb: Why do you think many financial advisors have generally been slow to embrace ETFs in their practice?
JJ: I believe product understanding and reluctance to embrace innovative products has caused advisors to embrace ETFs at a slow pace. Change is always difficult for any industry. Skepticism regarding a different product structure is always high due to the financial regulatory environment. As more advisors have seen their peers begin to fully research and utilize ETFs within their practice, they have become more comfortable. The ETF process can seem complex to many advisors and it takes time to fully understand the nature of ETFs.
ETFdb: Aside from the well-known benefits offered through the ETF wrapper, what do you personally embrace about this product structure?
JJ: I personally embrace the trading flexibility, market transparency, and tax efficiency of ETFs. The ability to research market trends and identify a specific vehicle to gain access to an attractive trend is key to building efficient and effective portfolios. Tax efficiency is becoming a larger concern for many clients, and we find ETFs provide a natural fit for this type of client.
ETFdb: Are there asset classes where you're more comfortable using ETFs and others where you prefer mutual funds or other vehicles?
JJ: We try to primarily utilize ETFs that provide broad access to the market, sectors, and countries. There are very few places in the market that do not offer exposure through ETFs.
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ETFdb: What do you expect in terms of ETF adoption going forward? What types of investors have been slow to adopt or are potentially major beneficiaries of embracing ETFs?
JJ: It seems major investment advisors are beginning to embrace ETFs more widely for seemingly efficient areas of the market, such as large cap U.S. stocks and broad global offerings. Clients have also begun to demand more flexibility in their portfolio holdings over the past few years. Buy and hold investing seems to have somewhat lost its luster. As clients push for more flexible portfolios, I believe advisors will further embrace ETFs. That said, tax conscious investors are potentially the major beneficiaries of embracing ETFs. The greater tax control that comes from measuring capital gains based off the client's holding period rather than a mutual fund's, as well as the ability to avoid the mandatory distributions that come each year from mutual funds, can be very attractive for a client concerned about taxes.
ETFdb: How are your strategies evolving in the low rate environment? What techniques are you using to deliver current income to your clients?
JJ: In January 2012, CLS launched a diversified income based strategy called Managed Income. This strategy is ETF-based, with exposure to a broad set of income-producing assets, including but not limited to: government bonds, corporate bonds, high yield bonds, preferred stocks, dividend-focused stocks, and real estate. The strategy may be implemented for the client at different risk levels based on their ability and willingness to accept market volatility. The utilization of ETFs gives CLS the ability to offer a flexible portfolio approach where trades can be placed to overweight certain income-producing assets that offer value and underweight others that do not. This diversified approach allows the client to avoid unnecessary concentration in one particular type of income-producing asset. In addition, the portfolio allows an inclusive bucket approach that allows the client to manage their distribution flows at a rate that is comfortable for them.
Bottom Line: In addition to the ease-of-use, transparency, and intraday liquidity benefits associated with the exchange-traded product structure, the tax-efficiency trait is a major advantage for self-directed and professional portfolio managers alike. The cost-efficient nature of ETFs and their ability to offer greater tax control makes these vehicles ideal for anyone looking to execute a long-term strategy.
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Disclosure: No positions at time of writing.
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