New England Private Wealth Advisors LLC is a fee-only registered investment advisory firm in Wellesley, Mass., that provides customized wealth management services for individuals, families and institutions with greater than $2 million in assets. Like a lot of financial advisors, the firm’s CEO, Ira Rapaport, has been incorporating exchange-traded funds into client portfolios to address a variety of needs. While some advisors stick to core, broad-based index tracking ETFs, Rapaport’s firm believes that thematic ETFs can hit the spot in highly customized portfolios.

Schlegel: What kind of ETFs do you use in client portfolios?

Rapaport: Our overall investment strategy incorporates the use of both active and passive strategies. Within passive investments selected for client portfolios, we may utilize traditional market-cap-weighted ETFs, equal-weighted strategies and/or investments that focus on other factor-based methodologies. In addition, we may select thematic investments specializing in areas such as health care, infrastructure, robotics and/or other technologies.

Schlegel: What is your firm’s investment philosophy when it comes to building portfolios?

Rapaport: We take a long-term strategic approach. Each client is unique when it comes to goals, objectives, time horizon, tax considerations, liquidity constraints and other considerations. We therefore create custom portfolios utilizing both active and passive investment strategies. Many of our clients have acquired significant wealth, so we have found it important to continuously focus on risk-adjusted returns and preservation of wealth.

ETFs are an important tool within our client portfolios, especially within taxable accounts. We believe ETFs have several attractive attributes, including tax-efficiency, transparency, liquidity and low expense ratios.

In order to complement ETF investments within a portfolio, we may allocate a portion to a balanced or tactical manager. This could be in the form of an active mutual fund where the management team can navigate several different asset classes. This enables a portion of a portfolio to be flexible. If we have conviction about a manager, we want to provide them more autonomy to make shifts to asset classes, sectors or geographies that they may find more attractive at any given time.

Schlegel: When did your firm start using ETFs, and how has that grown in your practice?

Rapaport: I founded New England Private Wealth Advisors in 2005. At that time, clients’ portfolios had a minimal allocation to ETFs. Over time, as the ETF industry has grown, both in assets and investment opportunities, ETFs have become an increasingly larger part of our client portfolios.

We have primarily utilized ETFs within the equity component of client portfolios. This has been mostly in U.S. exposure; however, we do also use international ETFs as well. Within fixed income, we have typically invested with active managers rather than fixed-income index ETFs.

Schlegel: Explain more about your use of thematic ETFs within your overall risk-adjusted approach.

Rapaport: We view thematic ETFs as more strategic than tactical investments. Our hope is that these investments may capture alpha in a tax-efficient growth vehicle. We estimate a holding period of more than three years.

We have utilized health-care ETFs over the past five-plus years. Over the past three-plus years, we have added infrastructure. More recently, we are including investments that focus on specific areas of technology, such as robotics and artificial intelligence.

The thematic investments we have selected invest globally. We believe the combination of the global and more sector-specific exposure provides an additional level of diversification. These ETFs do not just provide exposure to the traditional technologies giants found at the top of many market-cap-weighted indices.

Schlegel: Are you intrigued by the wave of smart-beta funds?

Rapaport: An important offering we provide our clients is education. It is important to us and our clients that the investment strategy can be explained and understood. As a result, we are selective in the area of smart-beta funds. We may utilize smart-beta products that are fully transparent and appear to have a focus on momentum, value, low-volatility, etc. We stay away from using “black box” type products.

Schlegel: How do you employ smart beta versus market-cap-weighted ETFs?

Rapaport: We do have some concerns regarding market-cap-weighted ETFs, as oftentimes the top holdings account for a disproportionately large percentage of the investment exposure. It is important that investors understand they may be investing in a concentrated portfolio, and thus incorporate it prudently into their portfolios.

Smart beta may provide an opportunity to be more diversified and may offer some downside protection. We strive to educate our clients that if the market declines 25%, you will need a 33% gain to break even. If the market declines 50%, you’d need a 100% gain. Thus, attempting to limit against large drawdowns while potentially giving up a portion of the upside may be a more prudent approach and may allow for a quicker recovery. This approach may be where something like a low-volatility ETF could be used.

Schlegel: What are you looking for in ETF providers?

Rapaport: We evaluate a number of different criteria when performing due diligence on investments. One important attribute is brand name recognition. The broad-based ETFs we use for traditional, low-cost core market exposure are generally from the big index providers—iShares, Vanguard, State Street, Charles Schwab or Fidelity. Some of the firms we use for smart-beta ETFs may include PowerShares, Guggenheim or First Trust.

Schlegel: You mentioned you prefer using active fixed-income managers, but are you looking into bond ETFs at all?

Rapaport: In certain instances we have utilized bond ETFs, and they tend to be traditional passive index exposures. Given the current interest rate environment, we believe active managers may be better positioned to provide attractive risk-adjusted returns.

Schlegel: Do you see any potential negatives from using ETFs in client portfolios?

Rapaport: Given the increasing options available in the ETF universe, some investors may not understand the underlying strategy and potential complexities. This may lead to investor confusion. Earlier, I mentioned market-cap-weighted ETFs and how an investor may think they are invested in a diversified fund while it is actually concentrated in the top few holdings.

There also may be certain areas of the market where active management has proven more beneficial.

We believe education is the key. If an investor receives an accurate explanation and fully understands the investment strategy, objective and rationale for holding that investment, we believe it may lead to better investment outcomes over the long term.