Why FAs Piled into ETFs Last Year and Will Further the Trend in 2019
Financial advisors used ETFs in client portfolios more than ever in 2018, Cerulli Associates data reveals. And market fluctuations, tax incentives, and increased comfort among older advisors may further the instrument’s popularity this year, sources suggest.
Allocations to ETF investments are “definitely going to increase in 2019,” John Swolfs, CEO of Inside ETFs, an ETF education company responsible for hosting the worlds’ largest ETF-centric events, says. “There have been 56 months of straight outflows from domestic equity mutual funds. Advisors are looking to move away from mutual funds,” Swolfs claims.
But when advisors move from mutual funds, they will “put client assets into ETFs,” he asserts.
And he’s not alone in his thinking.
James Sullivan, managing director of $16.5 billion AUM Private Advisor Group, says he sees “more and more advisors adopting ETFs” as “a direct supplement to mutual funds.”
Sullivan touts ETF’s tax-efficient structure as a motivator for the move from mutual funds. ETFs can be significantly more tax efficient than mutual funds because clients are not liable for taxes if fellow fund holders decide to sell, according to Investopedia.
Also, “large distributions on capital gains can come from mutual funds,” he says. If clients “are above a certain income level they may have to pay taxes on those gains,” he explains. Those taxes decrease client’s “overall return” and can push their advisor towards ETF investments, Sullivan explains.
Experts also point to stock market fluctuations as a motivator for increased ETF investment.
During volatile times “you see advisors looking towards ETFs,” Swolfs affirms. And that’s because advisors say ETFs are easier to use than “committing and tying assets to an active manager,” he explains. “If the market goes down, portfolios using ETFs lose value representative to how much the market decreases,” he says. But “active managers often ride the market down as much as ETFs, if not more,” he adds. “The idea that active management will save you in a down market is not necessarily true,” Swolfs claims.
Another big determinant of future growth in ETFs is a decreasing reluctance among senior advisors to adopt the investment vehicle.
More senior advisors have previously been reluctant to use ETFs because they are “still using legacy approaches,” Swolfs says. There are “a full generation of baby boomers from that era that have built successful practices with mutual funds and convincing them to change” can be difficult, he suggests.
Steven Check, president of $1.5 billion RIA Check Capital Management, when asked why he chooses to use a strategy of direct investing over ETFs, says: “Partially, it might be my age. I’ve been doing this for over 30 years and 30 years ago there weren’t things like ETFs.”
Both Swolfs and Sullivan predict more and more advisors will start using ETFs as time goes on.
Some FAs just “have to wade into the water first,” Swolfs says.