Rise of the ETF Asset Allocator

By Mark Raes

The growth of active management using ETFs as portfolio holdings is an emergent investment trend that is quickly gaining prominence — both as a stand-alone strategy, and as a combined approach where ETFs are held alongside security positions.

The increasing appeal of asset allocation as a primary tool for portfolio builders has been driving interest and asset growth for these strategies. The overwhelming market impact of macro-economic events, both positive and negative, such as interest rate decreases, Grexit concerns, and central bank quantitative easing programs has an impact on asset classes and geographies as a whole, lessening the impact of the return differentials between individual stocks.

True Diversification

In retrospect, the 2008 credit crisis was a watershed in the growth of ETF asset allocation strategies. Through that time, most investors saw less diversification benefits from their traditional portfolios, as many asset classes and securities moved down together. That experience has opened the minds of investors to look beyond traditional methods of diversification with direct holdings, and to consider approaches that provide more dependable diversification, such as ETF asset allocation strategies.

By tactically shifting between asset classes using ETFs, Asset Allocators achieve instant diversification in an exposure, as the ETF will typically hold most of the securities in that asset class. This is a significant benefit relative to buying individual positions where achieving a diversified exposure is both difficult and potentially costly, especially in harder to trade asset classes such as fixed income.

The Cost Advantage

ETFs are also low-cost investment vehicles, giving Asset Allocators better flexibility in making investment decisions. Investors recognize that unlike returns, fees are something they can control, and the focus on fees today is greater than ever before. With the release of regulatory initiatives such as fee transparency through CRM2, which has heightened fee scrutiny, ETF Asset Allocators are able to position their services as low cost, thanks to the underlying ETFs having lower management fees compared to other investment products.

Growth Means More Arrows in the Quiver

The growth of the ETF industry has meant that Asset Allocators have far better choices when it comes to building portfolios, both in terms of accessing new asset classes such as non-traditional fixed income, and adding more precise exposures such as maturity-segmented fixed income and further equity sectors or industries.

The rise of smart beta ETFs, that offer factor exposures such as quality, low volatility, and income, has meant that ETF Allocators can also capitalize on traditional biases of active managers to create portfolios while maintaining low costs.

ETF Asset Allocations are also well positioned to deliver alternative approaches where it is difficult to invest directly in areas of the market such as infrastructure, loans, and emerging markets bonds. In these cases, ETFs allow for a single trade on the exchange, just like a stock.

The rise of the ETF Asset Allocator is tied to investor trends that are gathering more attention: asset allocation, opportunities in alternative asset classes, and low fees, all of which means that their increasing relevance in the investing landscape should only continue.

Mark Raes is Head of Product, Global Structured Investments, BMO Asset Management Inc.