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Sunday, October 18, 2009

Brokers (Finally) Figure Out It Makes Sense to Use ETFs

Barron's this week published a gushing section on the growth and virtues of etfs (i guess they have been asleep for the last 5 years or more).

In an article entitled Why the Rich Like These Bare-Bones Products, Barron's writes how adviors to wealthy individuals have lately "discovered" how useful etfs are in structuring portfolios. In fact independent advisors like myself have been constructing portfolios primarily consisting of etfs for years.

The article mentions mostly "advisors" (read brokers) from the major "full service" brokerage firms that are just beginning to use the products.

The reasons mentioned in the article the newfound realization of the flexibility of the product (something independent advisors have know for years) and disappointment with actively managed mutual funds (something we independent advisors have know for years). Oh, and one more reason: their clients demanded them in their portfolios.

From the article my bolds and italics:

EXCHANGE-TRADED FUNDS don't exactly shout "I've arrived!" the way hedge-fund holdings or private-bank accounts do. But the well-heeled, as much as any investor, seem to appreciate ETFs' basic virtues: tax efficiency, low cost, transparency and liquidity.....

Ira Walker, a UBS advisor in Red Bank, N.J., uses ETFs to build entire customer portfolios. "With the push of a button, I can reallocate a portfolio, or I can diversify a portfolio into all asset classes," says Walker, who manages about $500 million of exchange-traded fund assets.

Firms like Morgan Stanley Smith Barney say that more and more of their clients are interested in ETFs;

ETFs can come in handy for tax harvesting, too. In a typical scenario, a group of stocks from a particular sector is sold at a loss, creating a tax-loss carry forward that mitigates a future capital gain. "We can replace that group of stocks by using an industry-specific ETF so we can maintain exposure to the sector," says Krasnoff

DISSATISFACTION WITH THE performance of some active managers prompted Jonathan Harris, executive director at Morgan Stanley Private Wealth Management in San Francisco, to start exploring ETFs about six years ago. "We had some clients back then who were frustrated," says Harris, whose team oversees about $2 billion. "They had some active managers who were not keeping up with the overall market and they were asking us how else we could approach things." That led to using ETFs in discretionary accounts, often for broad global-equity exposure.

None of the above should be new information for anyone that is a professional in asset management it has been apparent for close to a decade. I don't know if I should be shocked that Barron's just caught up with this or that the advisors at major brokerafe firms are just realizing it, or both

The unspoken reason for the adoption of exchange traded after years of resistance: they finally figured out a way to get paid for using etfs which pay no fees to brokers and can be bought with minimal commissions. You can read between the lines in this quote:

some private banks are even creating for their clients internal distribution platforms for ETFs. The financial meltdown, and scandals such as Bernie Madoff's Ponzi scheme, seem to have increased the appeal of plain-vanilla ETFs for those with millions at stake

But it seems like many "advisors" (i.e.brokers) still can't shake their old ways and still retain the myth that active funds belong in the portfolios:

High-net-worth advisors increasingly are experimenting with ETFs, which, unlike mutual funds, can be traded throughout the day. "We typically don't use ETFs for the core portion of a portfolio," says Mary Deatherage, managing director at Morgan Stanley Smith Barney in Little Falls, N.J. "We are more interested in using ETFs to complement the core holdings."

Of course if there were any justification at all for some use of active funds it would be in a portfolio structure exactly the opposite of that stated above. It would use etfs as the core holdings and perhaps, perhaps a couple active funds as a small (and likely fruitless) attempt to gain some alpha.

As we know hope springs eternal.

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