by Carly Schulaka
Carly Schulaka is a managing editor at FPA. Contact her at Carly.Schulaka@FPAnet.org .
After seeing a shift in core investing philosophies from 2008 to 2009, when clients and advisers were reeling from the market crash of October 2008, it appears advisers are regaining confidence in their investment decisions.
According to FPA's 2010 Trends in Investing survey-the third year such research has been conducted-advisers seem confident with the investment vehicles they currently use and recommend, namely mutual funds, cash and equivalents, exchange-traded funds, variable annuities, and REITs-all of which are being used by most planners, and that level of use has remained relatively unchanged from 2009.
Advisers are also more confident in their current asset allocation strategy than they were last year, with 60 percent of 2010 survey respondents saying they recently (within the last three months) reevaluated, or are currently reevaluating, the asset allocation strategy they typically recommend. And the majority of them consistently reevaluate. In comparison, nearly 75 percent of advisers were reevaluating asset allocations in 2009.
Likewise, advisers are more confident in their current retirement withdrawal strategy than they were last year, when almost 50 percent of advisers were reconsidering the withdrawal strategy they typically recommend. This year, just 39 percent are reconsidering their current withdrawal strategy.
These findings seem to indicate that advisers are comfortable with the changes they made in their investing philosophies from 2008 to 2009. Even as the economy is showing some signs of recovery, they are not reverting back to pre-October 2008 ways, but maintaining the changes made post market crash. Those changes include a move toward more risk-adjusted returns with a stronger emphasis on stability, simplicity, diversity, and alternatives to long-only strategies.
Trends in Investing survey results going back to 2008 show how ETFs and alternative investments, in particular, are continuing to meet these new investment needs and are gaining ground in more portfolios.
ETFs Maintain Their Appeal
Nearly 73 percent of survey respondents (excluding those who do not offer investment recommendations or manage portfolios) use or recommend ETFs, compared to 72 percent in 2009, and 44 percent in 2008.
Although the majority of advisers say they are using ETFs, those who use them are not necessarily allocating any more of their clients' portfolios to these products than in years past. The percentage of assets under management in ETFs remained pretty steady from 2008 to 2010, with an average of 14 percent of AUM held in ETFs in 2010, compared to 12 percent in 2009 and 16 percent in 2008.
"While many are predicting that ETF use will rival that of mutual funds in the next few years, that would require a rather significant shift in adviser use," says Rebecca King, manager of the FPA Research Center. "Advisers are using ETFs more selectively than they use mutual funds. Our research suggests that more advisers will start using or recommending ETFs, but that the actual amount of assets advisers dedicate will not increase to the level of mutual funds in the next few years."
Jim Vitalie, president of James Alpha Management, a seeding and distribution company focused on alternative investments, says two things are keeping ETFs from gaining significant market share from mutual funds. First, they need to further penetrate the qualified plan market, and actively managed ETFs need to be fine-tuned.
Ed McRedmond, senior vice president of institutional and portfolio strategies at Invesco PowerShares, which offers more than 100 ETFs, says a shift in business model for many advisers is helping maintain ETFs' popularity.
"More and more advisers are moving their business to a fee-based advisory model as opposed to transactional business, buying individual stocks and bonds, and that trend started a while ago, but it's continuing to drive ETF popularity," he says.
Where Are ETFs Headed?
With three quarters of advisers already using ETFs and 32 percent of those not already using them planning to do so in the next 12 months, many advisers are wondering what's next in product development and innovation.
William H. Belden, managing director at Claymore Securities Inc., which got into the ETF space in 2006 and now has 32 ETF products, says there is an industry-wide push to perfect actively managed ETFs.
"Current active strategies are not really active with a couple of exceptions," says Belden. "I really view active as the mountain to climb as it relates to active, fundamental delivery of securities. There will be truly active strategies in this space, and I think there is a meaningful amount of market share to capture. This is not the death of mutual funds, but I do think there is a market share to capture, and we're capturing some already, and once that nut is cracked it will just accelerate."
Belden also says there is still a huge opportunity for ETFs in the fixed income space. The trading market for fixed income is far less evolved than it is for equities, he says, and much of the limitation around fixed income products is the means by which bonds are bought and sold.
"As that market continues to evolve-and I'd like to think that the ETF market will push that evolution along-you'll see more fixed income strategies come and grow in a material way," he says.
Although Belden expects commodity-linked ETF products to continue to evolve, one caveat to that growth is the current regulatory environment. In March, the Securities and Exchange Commission announced it would conduct a review of derivative-based ETFs, including derivative-based commodity ETFs. As a result, new ETF products tied to commodities wait in development as the SEC completes its review and decides what, if any, additional regulations are required for derivative-based funds under the Investment Company Act of 1940.
Overall, Belden predicts increased competition in the ETF space, and that can be good for advisers and their clients.
"For the past several years, the ETF business has been a two-horse race between State Street and iShares," says Belden. "I think in three to five years there will be a notable difference in the lineup, if not in terms of ranking, at least in terms of market share."
Alternative Investments Gain Ground
The Trends in Investing survey broadly defines "alternative investments" as international/global real estate funds, futures, commodities, currencies, and structured products. Over the last three years, a consistent amount of advisers have indicated that they plan to increase their recommendation and use of alternative investments. In 2008, 47 percent said they planned to increase their use of alternatives. This percentage slid slightly to 42 percent in 2009, but rebounded in 2010 with 50 percent saying they will increase their use of alternative investments in the next 12 months.
"The rapid increase in alternative investments use among advisers was launched by the October 2008 crash, and the two most popular alternative investments currently are commodities and international/global real estate funds," says FPA's King. "This suggests that advisers are using alternatives as a tool to diversify, combat the effects of the down economy, and protect their clients from further loss due to turbulence in the markets or inflation. It also suggests that advisers believe we still have a long way down the road to a full economic recovery."
Vitalie of James Alpha Management says alternatives are a more sophisticated and proven way of enhancing returns and lowering risk in portfolios. He believes the trend we're seeing toward increased use will only accelerate as the support mechanism for alternative investments gets more efficient, including education, information availability, and mutual funds with alternative strategies.
"Advisers today need to distinguish themselves," says Vitalie. "Being able to adopt a more sophisticated portfolio theory and investment process to their practice incorporating alternative strategies and using alternative investment vehicles will help separate them from others; they will also be able to reach a more affluent client base."
This article is part of a Trends in Investing Special Report from the June 2010 Journal of Financial Planning. For complete coverage of the Special Report, visit www.FPAjournal.org/CurrentIssue/Supplements.