Twenty-one years ago, David Carmichael, a young ex-broker seeking to carve a niche as an independent financial advisor, realized that attracting the kind of clients he wanted might require farming out some of his investment responsibilities.
"My partner and I didn't have the credibility or track record to get the attention of wealthy clients with larger portfolios," he says. "So we decided to partner with third-party money managers that did." Today, outside money managers handle most of the $300 million in assets at Carmichael's Scottsdale, Ariz., advisory firm, Rowland-Carmichael, and two of those managers specialize in exchange-traded funds. Carmichael says the arrangement gives him more time to spend with clients on financial planning issues.
A growing number of firms specializing in ETF investment management are marketing their services to financial advisors like Carmichael who want to delegate investment responsibilities and spend more time on business building, financial planning and client retention. Such outside providers offer varying approaches. They can either take over the management of a large chunk of assets from an advisor or offer more hands-off, plug-and-play model portfolios that advisors can use as blueprints to make their own trades.
Still, convincing financial advisors to hand over the asset management reins to outsiders has been a less easy sell against the backdrop of Bernie Madoff and pummeled portfolio values. "We were growing at a pretty good clip until the credit crisis and bear market hit last year, but after that things slowed down quite a bit," says Herb Morgan, chief investment officer at a third-party ETF investment management firm, Efficient Market Advisors in Del Mar, Calif.
Still, the managers say they are determined to win over financial advisors, even if the process is a slow build. Morgan observes that in the last few weeks he's been getting more inquiries. "I think financial advisors are realizing that they need to come out of the bunkers and start spending more time attracting new business," he says. "Getting a third-party manager can help them do that."
Rob Stein, a managing partner at Astor Asset Management in Chicago, says the market downturn has actually made advisors more receptive to his services. "A year or two ago, we had to first convince advisors to go outside for investment management, then convince them to use us. Since the bear market began, we've seen greater interest in seeking outside help, particularly in our long/short strategies."
"Most of our investment management business comes from individuals and small companies, but we are seeing more interest from financial advisors who want us to manage their ETF portfolios," says David D'Amico, president of Braver Wealth Management in Newton, Mass. "This is going to be a much bigger part of our business five years from now."
Shopping Around
Advisors looking for third-party ETF management must heed the same caveats they would when dealing with any other investment manager. For one thing, they must put performance claims under a microscope. Published performance often does not reflect the impact of fees and transaction costs, which can significantly lower returns. Some firms provide unaudited performance histories, while others have track records audited by third parties. Because ETF management is a relatively new area, the managers may present data based on hypothetical back-testing rather than actual account results. As one firm's brochure states, "Annualized returns should not be construed as actual performance data, but as a reasonable representation of the returns that could have been achieved," given the fund's style and market conditions.
ETF portfolio managers differ from those that use mutual funds or individual securities in a number of respects. Because the funds are based on indexes and passive investment strategies, the firms typically distinguish themselves through strategic asset allocation rather than individual stock or mutual fund selection. Managers may allocate more of the portfolio toward alternative assets such as gold, commodities and currencies, since ETFs provide easier exposure to these non-correlated assets than either mutual funds or individual stocks. The ETFs offer more opportunities to manage taxes in the accounts than mutual funds since they are typically more tax-efficient. Because ETFs are easy to trade, a good number of the firms specialize in "tactical asset allocation" strategies that involve frequent trading as market conditions change.
An examination of the names in The ETF Managed Solutions Guide, a 262-page directory of ETF management firms published by Barclays Global Investors, reveals their diversity of experience, their advisory fees, their investment strategies and philosophies and their published track records. Some firms are generalists, while others specialize, focusing on income generation, on long-short strategies, on capital preservation, or on separate investment sectors such as growth or foreign stocks. Also represented are quantitative investors who make decisions in a highly disciplined, by-the-numbers environment and fundamentalists who look at the valuation characteristics of the individual securities. Some are niche players with just a few million dollars under management, while others control assets of $2 billion or more.