A whopping 87% of financial advisors currently use or recommend exchange-traded funds for their clients, according to the 2018 “Trends in Investing Survey” conducted by the Journal of Financial Planning and the FPA Research and Practice Institute. That far outpaces the share of those using mutual funds and individual stocks and bonds. So what’s keeping a small group of advisors from jumping on the ETF bandwagon?
The non-adopters say that ETFs—despite their low costs and tax advantages—aren’t the right fit for their business models or their clients’ needs.
Michelle Rand, a chartered financial analyst and president of Cascade Investment Advisors, a value-oriented RIA firm in Oregon City, Ore., is concerned ETFs may have a high concentration in certain stocks (such as the “FAANG” tech giants so heavily weighted in the S&P 500) and that they may be more liquid than their underlying assets.
For example, Rand says, small-cap ETFs, unlike small-cap stocks, trade easily in the marketplace, “So they give an illusion of liquidity that can prove very troublesome if everyone tries to sell at once in a market crash.”
And because ETFs have proliferated in the past few years, she adds, “they have not been tested by an ’08-’09 type market.”
Warren Hastings, a CFA and portfolio manager at Cascade Investment Advisors, notes that in fast-moving markets there can be greater variance between the bid/offer prices of an ETF and the same prices of its underlying assets. The same is true for those ETFs with less active trading.
Hastings also worries that authorized participants (people acting as floor brokers who offer a major source of liquidity for ETFs) attempt to calculate net asset value continually during market trading hours. During this inter-day trading, the price of the ETF depends on the depth of the market for the ETF, or how often it’s traded, and this can be different from the price of the underlying assets.
Len Fox, CEO of Scarecrow Trading, a Burnsville, Minn.-based RIA firm that also serves as an active money manager and investment advisor rep, says he prefers the simplicity of trading mutual funds at night to the chaos of trading ETFs during the day.
“It protects you from that and takes the emotion out,” says Fox, who reps for clients of Strategic Income Advisors in Escondido, Calif. “I’m not sitting watching all day.” Nor does he have to answer clients’ questions about inter-day trading.
“It’s not that I dislike ETFs. It’s that I love mutual funds,” says Fox.