Combining separate accounts with ETFs
By Don Wilkinson
DFW & Associates
Most advisors desire to be on the leading edge of the financial business in order to increase both their own productivity and that of their clients' portfolios. Two financial strategies which have been successful in their own right -- separate managed accounts (SMAs) and exchange traded funds (ETFs) -- are evolving to become the next superior wealth management product package, according to savvy financial advisors.
Take SMAs, for example, a product originally designed for the ultra-wealthy, but now with real-time reporting and enhanced computer advances that have brought down the cost of these special asset management vehicles to within the reach of middle-income investors.
Separate accounts provide tax efficiency and avoid the tax disadvantages of mutual funds. The investor, along with his investment advisor, can choose his wealth managers both on a strategic and tactical basis. The tactical managers are defensive in nature, moving to cash and fixed income in down markets with ETFs.
SMA investors can also customize their portfolios, instructing their wealth manager through their financial advisor to avoid specific sectors or stocks. For example, if your client is in the health industry and has a 401(k) with a large amount of medical technology equities, you can advise your client to diversify his or her financial exposure by avoiding the medical sector and medical-orientated stocks, in particular.
With separate accounts, the investor can choose market-beating wealth managers based on their performance. The investor can track the different managers' performance in growth stocks, value stocks, foreign stocks, etc to measure the performance of his or her portfolio. This is not possible with a mutual fund's portfolio.
SMA programs can be complex -- it's in their nature. Successful advisors are discovering the new breed of investor, as many mature baby boomers are seeking more simplicity within their portfolios.
Enter the ETF. The ETF solves multiple problems for typical high-net-worth investors. They make it simple. Instead of having five or more accounts to achieve adequate diversification, investors can cover every asset class in one SMA account by holding one ETF in each desired asset class.
The ETF has created a positive economic opportunity for the average investor. At the end of 2009, there were nearly 1,000 exchange traded products on U.S. exchanges.
Why? The big reason, heard time and time again, is that ETFs are mutual funds that trade like stocks with smaller management expense ratios. If you buy a mutual fund, you purchase a basket of stocks because it's easier and less expensive than investing in individual stocks. Remember, investors want to keep it simple.
Investors and traders can trade the ETFs just like stocks on the exchanges. A mutual fund has a fixed price on any particular trading day. ETFs, on the other hand, issue shares and these shares trade like traditional stocks This makes ETFs a useful tool for traders and investors alike. It's called liquidity.
The assets under management for ETFs are small to be sure compared to the mutual funds industry, which boasted over $8 trillion in assets at the end of 2009. However ETFs moved above $1 trillion for the first time at the end of 2009.
Besides liquidity, ETFs have lower operating costs than mutual funds. And this doesn't just apply to the initial purchase price; mutual funds continue to have notorious fees and charges that seem to hit the investor from every direction. By comparison, ETFs are more cost-efficient. Their expense ratio rarely exceeds 1 per cent. Most investors don't want to have expenses and fees eating away their profits.
And like SMAs, ETFS also feature tax benefits that mutual funds cannot match. Besides negative capital gains, even if the mutual fund has winning positions, they can accumulate gains that turn into a tax liability. Guess who pays? The investor.
It would be wise for the smart advisor to put his clients into an SMA, blending ETFs inside the portfolio to produce better results -- lower fees, lower taxation, and more accurate and predictable results in returns.
Some asset classes are not available through SMAs, such as alternatives like precious metals, real estate, preferred stock, etc. ETAs can fill a gap in sector classes that any investor requires.
In essence, separately managed accounts will be enriched by the inclusion of managed exchanged traded fund portfolios. Only now are more astute financial advisors recognizing that this is a probable evolution of these two important financial strategies. It's a powerful one-two approach that makes sense for the future.
In their June 2009 State of Managed Account: Industry Outlook, Cerulli Associates stated that more than 70 per cent of advisors expect to utilize managed accounts in the future.
With the powerful appeal of the ETF industry incorporating the best of the SMA platform offering, this new reality could come to benefit investors and financial advisors alike.
To make it even easier, do it through a platform for one-source client reporting, trading, and online services. This is the future. Don't be left behind, or another advisor who is more progressive may steal a portion of your client base.
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