Sydney-based financial advice outfit Omniwealth last year ditched all of its clients’ direct stock holdings and replaced them with six to seven ETFs.
It was a radical move, but Omniwealth’s senior financial adviser, Andrew Zbik, says the change not only delivers better outcomes for clients, but also creates a more efficient business model that frees up the firm’s advisers to focus on higher-value advice.
“I see managing a portfolio as a very small part of what I do as a strategy-focused planner,” he says. “Moving to ETF-based portfolios has freed up more of my time to concentrate on strategies that provide more value to the client.”
Omniwealth is one of an increasing number of financial advisers in Australia that are incorporating ETFs into their portfolio construction, but also using them to streamline their businesses in a post-FoFA, robo-advice challenged world.
But other advice practices are avoiding radical change, and while incorporating some ETFs into portfolios, they are largely protecting their existing models. They’re wary of ETFs’ risks and the loss of portfolio flexibility.
“ETFs absolutely aren’t for everyone,” Vanguard’s national manager, advisers, Matt Willis says. “It depends on the business model and audience.”
It is difficult to get an exact sense of how many advisers now use ETFs in portfolio construction. But there are indications the numbers are strong and rising. VanEck’s 2016 Smart Beta Survey of 120 planners found about 83 per cent are now using ETFs. “We found that quite high,” says Arian Neiron, managing director of global asset manager and ETF issuer VanEck Australia.
Independent planners responding to SMSF demand were the early adopters of ETFs, but their popularity is now flowing through to aligned advisers, with ETFs moving into approved product lists and licensees producing ETF reviews. “The driver really has been SMSF clients,” Neiron says.
Advisers are adopting ETFs for the same reasons they became popular with SMSFs: cost-effectiveness, transparency, flexibility of trading and tax efficiency.
When Omniwealth, which runs a managed discretionary account (MDA), switched to ETFs, performance and lower costs were two of the main reasons. S&P Global’s SPIVA Australia Scorecard report found that most actively managed funds in Australia, except the mid-cap and small-cap space, fail to beat indices over three- and five-year periods. “With active management, you pay 1 to 2 per cent fees, and platform fees on top of that, but don’t even make market returns,” Zbik says.
He estimates clients will save about 1 per cent a year in brokerage fees. Creating a fully developed portfolio across all asset classes using direct securities required an account of at least $300,000. “With ETFs, because transaction costs are lower, you can do that for $20,000.”
A basket of ETFs also removes stock selection risk. “It’s all asset allocation,” Zbik says.
But apart from portfolio strategic and tactical considerations, the impact on the adviser’s broader practice is also driving the increasing adoption of ETFs.
Vanguard’s Willis says the post-FoFA world has made more advisers think about what their true value proposition is. “Advice practices are under a lot of pressure from a cost perspective to be able to run viably,” he says.
Willis says a move towards ETFs aligns with Vanguard’s notion of ‘adviser alpha’ – how an adviser can add value by providing relationship-oriented services. That generally means a shift
from the adviser as stock picker to more asset allocator and behavioural coach.
“Advisers can’t just hang their hat on the investment piece,” he says. “They need to provide much broader and deeper value than that.”
ETFs are a way for practices heavily reliant on portfolios built through direct securities to remove or cut associated work, including rebalancing, administration and corporate action.
Zbik says the firms’ use of ETFs has altered the role of advisers. He believes planners who view themselves as portfolio managers have fallen into a trap. “True financial planners are not limited to selling product,” he says. “Strategy extends beyond managing a portfolio.”
Omniwealth now views its planners as ‘strategy-focused’ practitioners, who spend more time sitting down with clients, working out their goals and how to achieve them. They’re focused on issues such as debt reduction, cash flow management and property. “That has nothing to do with portfolio management,” Zbik says. “The ETF model “frees
up my time to provide better value to clients.”
He cites a recent client meeting. Just five minutes was spent on portfolio performance. The rest of the meeting focused on identifying strategies to plug a 20 per cent shortfall in likely retirement savings.
“I felt I provided much better value to the client.”
But a heavy shift towards ETFs doesn’t suit all practice models, Willis says; for example, traditional planning firms heavily reliant on platforms to administer their business’s back end might not embrace ETFs. Willis notes the price difference between index funds available on the platform and ETFs is minimal for such firms. “Moving down the ETF path may not be appropriate and may not be good for their client or business model. The index funds are a more than appropriate pathway to continue with,” Willis says.
Crystal Wealth Partners is one adviser that is incorporating ETFs for tactical reasons but isn’t making large-scale ETF-based portfolio changes.
Crystal executive director Tim Wedd says advisers, particularly those with access to strong research and resources provided by their licensee, can add value through careful portfolio construction and ongoing review. He said the level of ETF use “really comes down to the type of business structure you set up to manage portfolios”.
Where possible, under its discretionary portfolio mandates, Crystal Wealth seeks to go direct to the source of an investment exposure
in the most cost-effective way, to control portfolio costs but, more importantly, to control asset selection at a granular level.
Crystal may selectively add ETFs to portfolios.
The firm may use them as core building blocks to gain various market beta exposure, such as to the ASX 200, S&P 500 and commodities. Then active investments or funds can be introduced to add portfolio tilts or capture ‘alpha’ opportunities.
ETFs can also simply be used to target select tactical opportunities – such as gold, currency and bear strategies – as part of the overall blended portfolio design.
Wedd says in some cases ETFs can lead to a loss of flexibility in overall portfolio design by targeting a simple managed solution. For example, he notes that if the bond index was lengthening duration through the new issue of long bonds, then by implication the duration of an index-tracking ETF would also increase. An active bond manager could implement a range of strategies, including shortening duration, to mitigate such interest risks as required.
Liquidity is another risk, Wedd says, to be aware of with ETFs. “It’s fine to say you can buy and sell on an exchange and a market maker stands behind the ETF, but if conditions were tight then buy and sell spreads could blow out, particularly if the underlying ETF assets were impacted by difficult trading conditions,” he explains, adding “the more esoteric the ETF, the more the potential for future liquidity issues.”
Omniwealth’s Zbik agrees ETFs do create some risks, but says they can be mitigated. Omniwealth has an in-house policy of not buying synthetic ETFs, which use futures to mimic indices. “It’s opaque
and you’re not investing in something real,” he says.
Another challenge for advisers incorporating ETFs is the need for greater information and knowledge. Zbik says ETF information is quite broadly available. “Every provider has a plethora of information,” he says, including a full list of an ETF’s current holdings.
Omniwealth also uses Morningstar to get an overview of aggregate portfolio information. Morningstar provides a breakdown of an ETF portfolio’s exposure to factors such as geography and sector.
Neiron says advisers primarily go straight to ETF issuers or asset managers for the relevant information. VanEck provides an extensive education microsite on its website that details how to include ETFs in a portfolio. Neiron says advisers use the feature often. “They also look at model portfolios provided by asset managers, ETF issuers or research houses, which are an effective way to demonstrate how ETFs can be included in a portfolio,” he says.
Ultimately, how deeply an adviser incorporates ETFs into portfolio construction will depend on their business model and investment philosophy.
Omniwealth’s Zbik doesn’t expect too many practices to follow his firm’s 100 per cent use of ETFs for some time.
“If your business model is based on selling ‘portfolio performance’ and generating fees based on funds under management, I don’t think you
will necessarily like purely ETF-based portfolios,”
he says. “But as a pure fee-for-service firm, where our fees are based on time, it has been very easy for us to move to ETF-based portfolios.”
Greater use of ETFs is definitely a growing trend. “[A move to] 100 per cent ETFs is not happening en masse, but people are moving down that spectrum,” Vanguard’s Willis says.
