In his role as senior portfolio manager at Portfolio Design Advisors Inc., an RIA in Centennial, Colo., Wes Strode oversees the Axiom investment platform. This platform is available to financial advisors who prefer outsourcing their investment management and operation activities, and is designed for RIAs of all sizes whether they are a hybrid or standalone RIA. Its primary clients are advisors at the broker-dealer Geneos Wealth Management Inc., which is PDA’s sister company.

There’s roughly $2.5 billion on the Axiom platform, which has over 100 different models from various money managers—including large providers such as DFA and BlackRock—that advisors can choose and blend together. PDA contributes its own investment models to the platform, many of which rely on exchange-traded funds that span both broad exposures and target niches.

We recently spoke with Wes Strode, senior portfolio manager at PDA, about how his firm employs ETFs in its investment models.

FA: What are the different flavors of PDA’s investment models?

Strode: On the one hand we offer low-cost, risk-based model funds that cover all of the major asset classes for the lowest possible cost—internal costs on those investments are usually around eight to 10 basis points. We also have more specific niche models such as our ETF dividend payer model comprised of higher dividend-paying ETFs. Then we have a couple of stock portfolios, as well as some actively managed mutual fund risk-based models. In addition, we have some pure ETF risk-based models.

We run five different sleeves of risk-based models ranging from conservative to aggressive. The models consist of a core-and-explore approach. The core segment is comprised of large, low-cost ETFs for broad exposure such as the Vanguard Total Stock Market ETF (VTI) and the Vanguard Intermediate-Term Bond ETF (BIV). For the explore part we invest in areas where we see value; often this results in allocations to niche products such as factor ETFs or an ETF that tracks a subset asset class such as a fallen angels ETF or a frontier-markets ETF.

FA: How is your dividend-paying model constructed?

Strode: A lot of advisors and their retirement-age clients still have the mindset of withdrawing 4 percent a year from retirement assets in the form of interest or dividend payments so they don’t have to touch the principal. As a result, we decided to create a higher-paying model using ETFs. We use everything from preferreds and high-yield bonds to higher-paying equity ETFs such as pipelines.

It’s 100 percent ETF-based. It’s similar to a 50/50 model where we have about 50 percent in fixed income, and the rest in higher dividend-paying equities. Overall, the model has consistently yielded over 4.5 percent.

FA: What are some of the funds used in this model?

Strode: The iShares Preferred and Income Securities ETF, ticker PFF, which yields roughly 5.3 percent. We also use Invesco’s S&P 500 High Dividend Low Volatility ETF, ticker SPHD, and that yields about 4.4%.

FA: Regarding targeted niche products in general, what’s your criteria for using these types of ETFs?

Strode: A lot of times we like an investment idea and we know a particular ETF will give us pure exposure to that idea. With fallen angels, for example, these are corporate bonds that were investment grade but fell to junk, or high-yield status and are bought by the fund after they been classified as high-yield. Many investment companies’ mandates prevent them from holding non-investment grade, so these bonds often see additional selling pressure when they are reclassified to junk status. We believe that’s a good strategy for high-yield exposure, so we use the VanEck Vectors Fallen Angel High Yield Bond ETF. The ticker is ANGL.

FA: How do you approach factors in your portfolios?

Strode: The two main factors we use are quality and low volatility because we believe the risk-return tradeoff on these factors are beneficial. For quality we use QUAL by iShares [iShares Edge MSCI USA Quality Factor ETF]. With low-vol we also use iShares Edge ETFs such as the iShares Edge MSCI Min Vol Global ETF.

FA: Do you do much with actively managed ETFs?

Strode: We don’t use a lot of them, but we do use some. One is Pimco’s actively managed bond ETF, ticker symbol BOND. The hard part for us regarding actively managed ETFs is they’re fairly new and don’t have long track records, and as a result many of them have not experienced a prolonged bear market. Additionally, a lot of the newer ETFs are typically smaller, which can be a problem with trading as we run into issues when we trade more than10 percent of the daily average trading volume, so multiple executions are required. That can be a little bit of a hassle. Also, with smaller funds you have to pay attention to the bid/ask spread, and many times it is beneficial to ‘work’ the trade.

We do believe there’s still a role for actively managed mutual funds in the fixed-income space as we feel there are still some inefficiencies where managers can add value. That said, we have transitioned a majority of our equity exposure to passive investments.

FA: Any drawbacks to using ETFs?

Strode: As mentioned earlier, if you’re using smaller ETFs you have to pay attention to bid/ask spreads. Also, the ETF space is limited in areas where we believe active management can work. For example, actively managed funds with bottom-up management that employ certain characteristics such as GARP (growth at a reasonable price) or relative value can be tough to find in an ETF wrapper.

In addition, ETFs still settle at trade date plus two (known as T+2, which is a settlement cycle for securities transactions), whereas mutual funds still settle at trade date plus one. So when we trade accounts to raise money, ETFs take two days to settle and mutual funds take one day. A lot of clients don’t understand that, so when they need cash and want it wired to their bank account they wonder why there’s a delay when they sell from an ETF. It’s a small matter, but it’s still there.