Morningstar Advisor - August/September 2011 - (Page 40)

Spotlight that he or she cannot. The whole fund industry must be on pins and needles watching what happens with the launch of this fund. In the end, if ETF technology is good for passive investing, it will be even better for active investors and managers. Those distribution fees cost managers their stars and eat into investors’ returns. Passive investing is pretty tax-efficient in the first place, but active strategies will most likely benefit to an even greater extent. In the end, it is impossible to argue that more liquidity, transparency, tax efficiency, and lower costs are somehow bad things for investors, whether they are active or passive. Global Sea Change U.S. investors could buy only U.S. offerings, U.K. investors U.K. funds, and smaller markets like Dubai and Singapore have squat. But the network of exchanges tears down all of those borders. If investors have access to the New York Stock Exchange, they have access to all of the securities listed on the exchange, regardless of where they reside in the world. Additionally, they could cross-list the fund on any number of exchanges in local markets. This has already happened with passive ETFs. According to filings, it is not uncommon for a passive ETF to have international ownership ranging anywhere from 30% to 60% of total assets. It will not be any different for active managers. Why more star managers aren’t following Bill Gross’ lead and launching active products on the exchange to gain more access to international investors is mind-boggling. In terms of regulation, the United States is actually playing catch-up to a few countries. The United Kingdom and Australia already have plans to mandate fee-only advising starting in 2013. Both countries are much further behind in natural adoption of fee-based advising, so the abrupt change should be far more disruptive to their advisor markets, though the outcome will ultimately be the same. Revolution or Evolution? The impact of the national exchanges, ETFs, and fee-based advising won’t just affect the United States—it will have global implications. One of the side effects of the ‘40 Act and similar legislation around the world is that they created geographic investing silos. That is, The forces dictating the sweeping changes that are affecting how funds are sold are already in motion. If you want to know why these things are happening, don’t look to the symptoms, namely passive investing and ETFs. Instead, look to the root of the cause in fee-based advising and technology revolution that is clearly under way and only gaining more speed. In the end, the investor is the winner and the “fee eaters” and “commission addicts” are the losers. Investments will be “bought” and not “sold” as would happen in any efficient capital market. At least, that’s our theory. K Scott Burns is Morningstar’s director of ETF, closed-end, and alternative fund research. Paul Justice is director of North America ETF research. Here Come ETF Managed Portfolios By Andrew Gogerty The next stage in the growth of ETFs is the managed portfolio. Available primarily as separate accounts, these portfolios are (in most cases) actively managed investment strategies designed to outperform a passive benchmark. As the name implies, the advisor or third-party manager primarily uses ETFs, not individual stocks or bonds, to achieve clients’ investment objectives. As a result, these portfolios can be diversified across geographies and asset classes—just like traditional stock-and-bond portfolios—but the use of ETFs means that diversification is pursued through a dozen holdings or less. Though little has been written about these strategies, advisors and third-party managers have responded to client demand for such portfolios. More than $10 billion is invested across just 300 or so strategies, and the numbers continue to grow. In addition to transparency and liquidity, many of these strategies offer more tactical flexibility compared with traditional separate accounts. Because of the ETF structure and its liquidity, the ability to move quickly between asset classes such as stocks, bonds, and cash can often be accomplished with just one or two trades, rather than through tens or even hundreds of trades in a stock portfolio. The Good Harbor U.S. Tactical Core strategy, for example, benefited from a move out of equities in 2008, generating a nearly 1% gain that year, and subsequently moved back into U.S.-focused equity ETFs to capture the market’s rally in 2009 and 2010. Despite the attractions of the ETF managed portfolios, advisors still need to do their homework. While some strategies have been around for five or even 10 years (the Good Harbor strategy began in early 2003), many haven’t been around that long, and most do not have the benefit of hindsight in back-testing their models. Like all crowded areas of the investment landscape, these portfolios are trying to beat a benchmark, something we know isn’t always going to happen. In the coming months, Morningstar will be rolling out a suite of new reports, commentary, and data analytics to help advisors better evaluate these strategies. Our effort will increase the awareness and transparency of this growing part of the industry, provide a road map for third-partymanager due diligence, and give advisors tools to set expectations for their clients. Stay tuned. Andrew Gogerty is Morningstar’s ETF managed portfolios strategist. 40 Morningstar Advisor August/September 2011

Table of Contents for the Digital Edition of Morningstar Advisor - August/September 2011

Morningstar Advisor - August/September 2011
Contents
Contributors
Letter From the Editor
Simplicity and Design Matter
Do You Use ETFs Strategically or Tactically?
The Institutional Way
How to Analyze an ETF
Eyeing ETFs’ Next Chapter
Small-Cap/Large-Cap Flip-Flop?
Four Picks for the Present
Investment Briefs
Morningstar Investment Conference
Pitfalls of Peer Groups
A REIT Recovery, With a Catch
Turning Fund Distribution on Its Head
Here Come ETF Managed Portfolios
Circle These Picks Amid the Crop of New ETFs
ETF Analyst Favorites
Beware, the Accidental Portfolio Manager
It’s the Destination, Not the Vehicle
New Growth, Rooted in Experience
Better Ways to Look at ETFs
How to Better Manage Your Clients’ Future(s)
More Bargain Than Bubble
Cheap, Local, and On a Roll
Mutual Fund Analyst Picks
50 Most Popular ETFs
Undervalued Stocks With Wide Moats
First-Quarter Assets Hit an All-Time High
You Say You Want a Revolution?

Morningstar Advisor - August/September 2011

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