During a year marked by heightened volatility and quick market runs, financial advisors exhibited an increased willingness to utilize ETFs in client portfolios to quickly navigate the stormy conditions.
According to Cerulli Associates data, financial advisors used ETFs in client portfolios more than ever in 2018, and the heightened market fluctuations, tax incentives and increased familiarity among older advisors could further support the popularity of the investment vehicle this year as well, Financial Advisors IQ reports.
Allocations to ETF investments are “definitely going to increase in 2019,” John Swolfs, CEO of Inside ETFs, told Financial Advisors IQ. “There have been 56 months of straight outflows from domestic equity mutual funds. Advisors are looking to move away from mutual funds.”
Furthermore, Swolfs argued that as financial advisors make the shift out of mutual funds, more will “put client assets into ETFs.”
As the mutual fund industry steadily bled assets over the past decade, the ETF industry has been a direct beneficiary of the massive shift in assets. According to Cerulli Associates, 14.1% of financial advisors’ client assets are allocated to ETFs as of the 2018, compared to 5.4% back in 2009.
James Sullivan, managing director of Private Advisor Group, pointed out that there are “more and more advisors adopting ETFs” as “a direct supplement to mutual funds.”
Rising demand for ETFs
Fueling the rising demand for ETFs, many highlight ETFs’ tax-efficient structure through the so-called in-kind creation and redemption process where baskets of underlying securities are exchanged in-kind for ETF shares, which diminishes the likelihood of capital gains distributions for investors. ETFs are significantly more tax efficient than mutual funds since investors are not liable for taxes if fellow fund holders decide to sell.
“Large distributions on capital gains can come from mutual funds,” Sullivan told Financial Advisors IQ. If clients “are above a certain income level, they may have to pay taxes on those gains.” Those taxes decrease client’s “overall return” and can push their advisor towards ETF investments.
Other observers also underscore the stock market fluctuations as another motivating factor behind the increased ETF usage.
During volatile conditions “you see advisors looking towards ETFs,” Swolfs said. Advisors aruge that ETFs are easier to use than “committing and tying assets to an active manager. If the market goes down, portfolios using ETFs lose value representative to how much the market decreases,” but “active managers often ride the market down as much as ETFs, if not more.”
“The idea that active management will save you in a down market is not necessarily true,” Swolfs added.
For more information on the ETF industry, visit our ETF performance reports category.