ETF Share of Broker/Dealer Wraps Seeing Slow Growth

At the end of 2010, exchange-traded funds (ETFs) reached 25% of retail fund assets in wrap programs at national broker/dealers (B/Ds), up from 22% at the end of 2008. 

The findings are part of a report from Strategic Insight, an Asset International company. “How Financial Advisors Use ETFs” examines how ETFs have been gaining ground at national B/Ds – firms such as Morgan Stanley Smith Barney, UBS and Wells Fargo – but growth has been at a modest rate.  Strategic Insight says their growth has roughly matched the organic growth rate of mutual funds in wraps since mid-2009. The reason for this may be that some of the heaviest ETF users in these wrap programs swayed back to mutual funds as the stock market rose.

“ETFs continue to gain ground in national broker/dealer wrap programs, but most of their growth is in newly invested assets – not through advisers who are selling out of active mutual funds in order to switch such assets into ETFs,” said Loren Fox, senior research analyst at Strategic Insight and the report’s author. “ETF firms have great opportunity in capturing incremental growth, while mutual fund firms have an opportunity in winning back adviser interest via innovative funds.”

Within national B/D wraps, the most popular types of ETFs in 2010 largely mirrored the mutual fund universe: the top three ETF styles in net inflows were emerging markets equity, “specialty” (a catch-all category for gold and other commodities, natural resources, and inverse ETFs), and taxable fixed income, according to Strategic Insight’s research. With the exception of inverse funds, these three categories were among the most popular mutual fund styles in 2010 as well.

The study also concluded that ETF use is particularly heavy within Discretionary Rep-as-PM (Portfolio Manager) wrap platforms, programs in which the financial adviser maintains discretion to make account transactions on behalf of their clients, without prior client approval. At the end of 2010, within the two large national B/Ds that Strategic Insight studied, ETFs accounted for 54% of retail fund assets in Rep-as-PM programs. Financial advisers working in Rep-as-PM programs have a greater inclination toward early adoption of ETF use, Strategic Insight found.   

However, as the recovery of the stock market progressed in recent quarters, mutual funds regained some market share within Rep-as-PM programs; the report suggests that the beneficiaries have been nontraditional and flexibly mandated mutual funds – implying that unique active mutual funds have the potential to attract even the financial advisers most heavily invested in ETFs.

“How Financial Advisors Use ETFs”also looked at portfolio construction using ETFs, and found that ETF use within Rep-as-PM programs was growing faster in “satellite” styles (specialty funds, sector equity funds, emerging markets funds, real estate funds and high yield bond funds) than in “core” portfolio positions (U.S. and international equity and fixed income). The study found that 30% of ETF assets in Rep-as-PM programs were used in satellite strategies in Q3 2009, and that proportion rose steadily to 35% in Q4 2010. “More and more ETF launches encompass ‘satellite’ strategies, so we expect satellite strategies to take a growing share of the ETF market,” said Fox.

Details on purchasing the report are available at “Report Examines How Financial Advisers Use ETFs.”