Earlier this month, State Street Global Advisors [SSgA] (NYSE:STT) held a one-day conference called SPDR University, in honor of its flagship ETF product. While the conference featured sessions on the outlook for the global economy and how to help clients make better investing decisions, its main focus was to convince registered investment advisors to use exchange-traded funds.
There's nothing wrong with a company educating the public and investing professionals about how to use a new product. Invesco (NYSE:IVZ) PowerShares Capital Management instituted a similar PowerShares University last year. No; the question is, why is it taking the registered investment advisor community so long to jump on board with some of best products now available for their clients?
"In the financial services business, it doesn't always pay to be an early adopter," says Dennis Clark, chief executive of Advisor Partners, a San Francisco-based provider of investment ideas to advisors of high net worth individuals.
"Registered investment advisors are some of the slowest adopters in the business and 98% of the time, that's not a bad thing. Nor is there a lot of incentive to be on the leading edge."
One only needs to look at the slew of securities that repackaged subprime mortgages to see how an initial dose of skepticism for new products can be a selling point for the typical Registered Investment Advisor (RIA). But, ETFs have been around for 15 years.
To coincide with the launch of SPDR University, SSgA released a survey on how investment professionals use ETFs. The survey, a joint project with the University of Pennsylvania's Wharton School of Business, interviewed 840 investment professionals. Out of this group that included financial planners, wealth managers and bank professionals, 30% were broker-dealers and 28% RIAs. While 67% of all the professionals agreed that ETFs are the most innovative investment vehicle of the last two decades, the majority said they were only light users of the products, with less than 24% of their portfolios utilizing ETFs. Surprisingly, 59% of all the respondents had less than $5 million worth of assets invested in ETFs.
"It's not that they're completely unaware; it's more that they are overwhelmed by the choices," says Ed McRedmond, senior vice president of portfolio strategies at Invesco PowerShares. He says most of the advisors who attend PowerShares University don't want "ETFs 101," but more information about second- and third-generation ETFs. "It's tough for anyone to keep track of all the ETFs that have hit the market and to understand the differences in construction methodologies."
The State Street survey bears this out. Of the advisors surveyed, 69% cited "unknown and untested indexes" and the "overwhelming number of choices" as the two biggest disadvantages of ETF investing.
But it might not be unknown indexes as much as indexing itself that presents a problem for many investment advisors. Many RIAs originally started out as stockbrokers trained to sell their firm's stock pick of the day. So, they feel the value they offer clients is as stock pickers.
"A lot of advisors feel that if they use a vanilla index product, then their clients will question their value: ‘Why do I work with you when I can buy it on my own'?" says Rudy Aguilera, chief executive of Helios, a fee-based RIA firm in Orlando, Fla. "Advisors need to work on the value of the process of asset allocation and not rely on how the assets are depicted in the portfolio."
Brock Moseley, managing director of Miracle Mile Advisors, ETF-based investment consultants in Beverly Hills, Calif., says even advisors trained to focus on asset allocation are taught that the most important decision they can make is to find best-of-breed managers who do incredible research and can outperform the market. Advisors also like the idea of being their clients' gatekeepers. They sell clients the concept that they can provide hard-to-get-access to investment managers and opportunities.
The problem here is twofold. Investment advisors will have to eat some crow if they admit that indexing works as well or better than these "best-of-breed" managers. More importantly, it's hard to justify high fees when selling index-based products.
Moseley adds the industry is getting older as well and that this could be a case of the difficulty in teaching old dogs new tricks. New business school graduates who might believe in ETFs see the RIA business as just a cutthroat sales job. Instead, they join hedge funds and private equity firms, leaving the RIA business to a generation of older professionals who don't even know, or care, what an ETF is.
While the survey suggests that "use of ETFs tends to correlate with an advisor's years of experience," no hard data is given to back up this claim.
The Pressure's On
"A lot of older guys don't want to deal with this," says Moseley. "Why sell a client a manager, then move them into an index product? That is a lot of work." But, he adds, large broker-dealers and investment banks are now being pressured into trying to figure out how to use ETFs in their client portfolios.
Advisor Partners' Clark says there are two indications that a firm has waited too long to make a change: when it starts losing accounts, and when its biggest clients start asking, "Why don't you know about this?" So, more than anything else, it's the clients who are moving the industry in this direction.
Among RIAs who use ETFs, the SSgA/Wharton survey also found that the product's strongest appeal was liquidity and low cost, with tax efficiency, intraday trading and investment style purity are also considered important. The ability to sell short wasn't a big sell for advisors. About 24% of the advisors who used ETFs felt that big tracking error was a significant issue. About 43% of survey respondents said 401(k) plans offer the greatest potential for future ETF growth, with 27% suggesting actively managed ETFs. As for exchange-traded notes, 64% of the respondents said they don't understand how ETNs work, and only 29% said they expect to use ETNs more in the future.