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.

Fee arrangements also vary. Some provide almost no published details about how they are compensated. Those that disclose fee information typically publish annualized advisory fees of 1% to 2% of assets under management, depending on account size. At that level, third-party management fees may be more than five times the annual cost of the ETF itself.

The extra 100 to 200 basis points in subadvisory management fees might seem to conflict with the appearance of low costs that have long been the major selling point of ETFs. But there are firms that charge less, and as they try to attract assets in a bear market some may be willing to negotiate fees. "We're more inclined to negotiate when larger accounts are involved, but the possibility is always on the table," says Byron Green of Green Investment Management in Fort Worth, Texas. Fees at his firm start at 95 basis points for accounts of $100,000 and slide down to 50 basis points for accounts of $1 million or more. Carmichael says he pays 35 to 75 basis points for outside ETF portfolio management, which is significantly less than the 100 basis point tab that active stock managers he works with typically look for.

Most of the firms prefer to work as subadvisors rather than giving advisors model portfolios to implement themselves-and execute their own trades-since that arrangement is less lucrative for the managers. D'Amico says that his firm usually acts as a subadvisor by taking charge of a portion of client assets for a set fee based on assets under management. Occasionally he will provide the model portfolios to advisors, but he prefers a subadvisor role since "that's the only way we can be sure that our portfolio strategies are really being followed." Stein's firm doesn't provide models for advisors to implement themselves, but it does offer a subscription-based newsletter with information and data advisors can use to build their own ETF portfolios.

Other firms feature model portfolios prominently in the investment process, although they generally implement them in-house. Efficient Market Advisors segregates its different model portfolios with target dates based on the number of years until someone needs to begin drawing on the account. These portfolio time frames range from two years to 20 or more, and investors can choose from among conservative, moderate and aggressive investment tilts for each target date. Based on the investor's answers to a time and risk profile questionnaire, the advisor is assigned one of 15 investment models designed by the firm. The service includes quarterly reviews and automatic rebalancing when required. The minimum account size is $100,000, with a maximum charge of 50 basis points.

Braver Wealth Management takes a conservative approach with its strategic portfolio, which invests in a mix of stocks, bonds, cash and alternatives and has a maximum exposure to equities of 60%. The firm's tactical allocation models take a similar approach, but with more short-term shifting among investments.

Astor Asset Management uses a macroeconomic overlay in its strategies. During economic contractions, the portfolio takes a defensive position with either large cash positions or with ETFs that have inverse market exposure. The Preferred Growth Program has an actively managed portfolio allocation to large-, mid- and small-cap domestic equity and to international ETFs, along with specialty-sector ETFs such as short-term bonds, energy or utilities. The Preferred Stable Program emphasizes dividend and interest income.

Green Investment Management uses a few different approaches. Its Balanced Growth portfolio mixes stock and bond ETFs with an emphasis on stock. The Balanced Mosaic portfolio includes more alternative assets and sector rotation strategies. Guardian Country is an aggressive allocation strategy designed to participate in foreign country or region-specific ETFs with recent relative strength. It generally invests in funds from three to five different foreign countries.

Green works with 68 advisors who bring in accounts ranging from $100,000 to $25 million. Advisors typically start by handing over their smaller accounts and bringing over more assets once they feel comfortable with the advisory relationship.