ETF Managed Portfolios: Cheaper Diversification?

Active managers building with ETFs.

June 12, 2013

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jelly beansI’ve been writing a lot lately about the slow and steady uptake of exchange-traded funds in Canadian pension portfolios. ETFs are kind of like the houseguest who eventually moves in—plan sponsors use them as a short-term place to park money and, over time, they just leave them in the portfolio. Slowly but surely, ETFs are finding a long-term home in Canadian pension funds, instead of simply being a quick and easy way to get in and out of markets.

But the next wave of products aims to push the ETF envelope from ad hoc adoption to strategic allocation. This is where ETF managed portfolios come in. A recent article in Pensions & Investmentssays managed portfolios are becoming a feature on the investment menu of U.S. pension funds. According to Morningstar, an ETF managed portfolio is a separate account strategy where at least 50% of assets are held in U.S.-listed ETFs. Such products grew by 60% in 2012 and the firm currently tracks 530 strategies from 125 firms with assets totaling US$63 billion.

Impressive numbers, but it seems like a tough sell for pension funds looking for a product it can squeeze into an asset allocation model based on traditional asset classes. And for many, this mixed bag approach espoused by ETF managed portfolios doesn’t cut it.

But that is slowly changing as more and more providers in the U.S. look to ETF managed portfolios as a jumping off point for institutional business, including pension funds and endowments. And institutions are biting. At the front of the line, the $28.4 billion Arizona State Retirement System allocated 20% of its portfolio to Boston-based Windham Capital Management LLC in 2011, a firm that is entirely invested in ETFs. Another firm, Sage Advisory, offers its institutional clients fixed income, tactical ETF and liability-driven strategies according to Pensions & Investments. Twenty percent ($2 billion) of its portfolio is in ETFs.

As more and more managers seek to deliver the benefits of ETFs to their pension clients, managed portfolios could see a lot of interest from institutions looking for cheaper ways to diversify. In fact, the rise of ETFs in pension portfolios could create some serious competition for the hedge fund industry. Keith Goddard, CEO of Capital Advisors, told Pensions & Investments that tactical ETF strategies have similar diversification benefits to hedge funds at a fraction of the cost.

So can ETF-based portfolios go head to head with the hedge fund industry? It’s an interesting question and it points to yet another way these products are shaking up the institutional investment space.

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