Live updates from Morningstar's inaugural ETF conference.
Articles and videos will be added as soon as they are produced, with most recent entries first.
Portfolio Construction: Best Practices From the Pros
Bob Goldsborough, an ETF analyst with Morningstar, introduced the three panelists; Michael Iachini, who runs Charles Schwab's ETF wrap program; Hal Ratner, Asset Allocation Strategist with Morningstar Associates; and Rick Ferri, CEO of Portfolio Solutions. The first item on the agenda was explaining their approach to portfolio construction. Michael's Schwab Managed Portfolio's approach is pretty simple: diversification across asset classes. With the all-mutual fund portfolios, they concentrate on picking good managers. With the all-ETF portfolios, they concentrate mostly on basic strategic allocation, but with the addition of a tactical overlay within asset classes. Hal uses ETFs with client portfolios at Morningstar Associates to implement a specific asset allocation strategy. He finds this approach useful in limiting risk. Rick also looks at a particular client's need to inform his strategic asset allocation approach. Once you choose an asset class weighting, the next step is finding the right investment, be it an ETF, open-end index fund, or actively managed mutual fund. Then it's simply buy, hold, and rebalance.
The next question raised concerned what type of ETFs they use in their portfolios. Michael uses domestic and international equity, sector equity, commodity, and real estate ETFs, but no currency, leveraged, or actively managed ETFs. Hal uses mostly plain vanilla index ETFs, but wishes there were more fixed income ETFs, particularly international. Rick eschews fixed income ETFs, and doesn't invest in commodities at all.
While the panelists all use strategic asset allocation, there are some unique approaches. According to Rick, years ago 90% of advisors were strategic; now it's between 30-40% strategic, 60-70% tactical. Hal doesn't use a fixed beta, because correlations can change over time. When they do, he responds by shifting allocations so the overall portfolio risk level remains in line with client expectations. Michael calls his approach the enhanced index approach; allocations are pretty much fixed, but within the asset class there is movement.
Next they discussed problems in building a portfolio. Hal stated that liquidity can be an issue with large clients. Rick sometimes had problems when rebalancing between mutual funds and ETFs because the products have different settlement dates and depending on the custodian, clients could be charged for margin while the transactions settle.
Some advice the panelists shared for financial advisors is that the first step in understanding a particular ETF is understanding the index that the ETF tracks. Michael also preached understanding the client, and what they want; buy and hold, or more active management.
Tracking error was another interesting topic. According to Michael, measurement is important. His firm uses market price returns to measure ETF tracking error, which introduces the need to adjust for serial correlation. For example, with international ETFs where the underlying components trade in a different time zone, the ETF can trade away from the components during the hours where the domestic exchange is closed, until the following day when it reopens. Rick reminded the audience that tracking error isn't exclusive to ETFs, but open-end funds can also suffer from it.
The panelists agreed that they aren't doing much activity in anticipation of tax changes coming out of Washington, but Rick did mention that he is harvesting tax losses in case long-term capital gains taxes go up. None of them were fans of equal-weighted indices, because they basically are just disguised mid-cap indices. If a client wants that exposure, they would rather just use an ETF tracking a mid- or small-cap index which has a lower cost. They also suggested that two areas where they would rather use active managers rather than a passive, cap-weighted ETF would be with high-yield debt (because a cap-weighted index overweighs the riskiest debt) and commodities (because of the negative roll yield in the futures market due to contango).--Alan Rambaldini
Looking For Yield
In the "Looking For Yield" panel at the ETF conference panelists got to hear from Fran Kinniry from Vanguard, Ed McRedmond from Powershares, and Don Suskind from PIMCO. Today's clients are fixated on the need to find yield-producing funds for their portfolios. The panel focused on how the different strategies used by their firms can help advisors find that yield in a low-cost, diversified ETF product.