ETFs present a special challenge to the advisor when it comes to generating revenue: they act like a mutual fund, but don’t pay a trailer. They’re exchange-traded and commission-based, but have lower turnover than individual stocks. That said, the more actively traded the ETFs, the more a commission-based model can work.
Should investors spend time choosing the best manager, or diversifying?
In my last article, I noted that a portfolio manager's return is made of two components: beta and alpha. Beta is the return you get by investing in various risk factors, like market risk.
In my last article, “The true cost of beta,” (June 2011), I noted that a portfolio manager’s return is made of two components: beta and alpha. Alpha is the extra return generated through manager skill above the return accounted for by the risk premium of the underlying factors the portfolio is exposed to. Alpha is a rare and fleeting commodity that fetches a higher price if it’s sustainable in the long run. Alpha is what is left after we’ve accounted for the beta portion of a manager’s return — it’s a residual value.
So how does one go about getting alpha? The only way is to get off the benchmark and loosen investment constraints such as limits on short selling, portfolio concentration, and types of markets and securities allowed in the portfolio.
There are two components of an active portfolio’s return. Beta is passive and stems from simply being invested in the market. The other, alpha, stems from a manager’s skill in selecting investments that will add return above what the market gives on its own.
There are two components of an active portfolio’s return. Beta is passive and stems from simply being invested in the market. The other, alpha, stems from a manager’s skill in selecting investments that will add return above what the market gives on its own.
ETFs present a special challenge to the advisor when it comes to generating revenue: they act like a mutual fund, but don’t pay a trailer. They’re exchange-traded and commission-based, but have lower turnover than individual stocks. That said, the more actively traded the ETFs, the more a commission-based model can work.
When we made the decision to incorporate ETFs as a core in our advisor business model, we knew the changes we were proposing were major. Clients weren’t yet well versed on the new instruments. They also had to struggle with new nomenclature, a new portfolio structure, transparency of fees and index-based management.
Because their many benefits outweigh their few shortcomings, we expect ETFs to represent a much greater share of managed assets in the future. But some structural issues within the advisory industry need to be addressed if ETFs are going to take centre stage alongside today’s more mainstream managed products.