This week's issue of Barron's [subscription required] takes an interesting look at Exchange-traded funds, and their growing prominence. According to the piece, "A survey by Schwab Institutional [...] taken in January, covered nearly 1,400 advisers representing $347 billion in assets under management, and found that 76% of them currently use ETFs in client portfolios. No other instrument had a higher usage rate. Fully 36% said they expected to increase their ETF use, and one in five advisers who don't yet use them expected to begin doing so."
It's great to see advisers increasing the use of ETFs. ETFs often have lower expense ratios than mutual funds, partly because the vast majority are passively managed index funds. A shift to ETFs in all likelihood means a shift away from actively-managed funds, and as reams of data show, that is great news for investors.
However, as always, I think investors can do better with ETFs without a financial advisor. ETFs generally are tax efficient and have low expenses, but adding the expense of a financial advisor can make those fees look a lot more expensive. Active trading tends to eliminate their tax advantages.
Barron's also warns investors about another potential pitfall that may come as new ETFs seem to sprout up every week:
- Part of the reason it's so easy these days to roll out new ETFs: regulators' tendency to approve nearly any vehicle based on an index, however the ETF sponsor chooses to define "index." Is a U.S. state anyone's real idea of a benchmark? How about a basket of stocks recommended by a handful of small research shops?
[...]
There's nothing inherently wrong here. But calling a geographically or analytically screened stock basket an index can spawn confusion among investors who might think they are getting passive exposure to a market segment, when in fact they are adopting a specific -- and often untested -- investment strategy.
In general, most investors should probably stay away from new and exciting ETFs and stick with the old boring ones that have delivered such solid returns. As Jeremy Siegel has said, in investing, the tried and true tend to triumph over the bold and new.
