A recent ETF Insights by ETF Database featured a Q&A with me. I talked about my experiences with Exchange Traded Funds (ETF) as well as where I think the industry is heading. You can view the article here.
ETFs have found their way into countless portfolios as investors of all walks have embraced these vehicles as the preferred means for achieving low-cost, diversified exposure to virtually any asset class. While the product lineup continues to grow every week, with the total number of ETPs now approaching the 1,500 mark, many still feel hesitant to jump aboard or are perhaps intimidated by the sheer variety of offerings available at their fingertips. Kirk Kinder, founder and President of Picket Fence Financial, recently took time out of his schedule to discuss what he feels remains a roadblock to ETF adoption rates as well as his personal experiences and observations regarding the development of the industry as a whole.
Kirk Kinder (KK): I think a couple reasons exist as to why advisors haven’t embraced ETFs in their practice. The first is education. It requires the advisor to become educated on how ETFs function, the landscape of the industry, and how the underlying benchmarks are created. It also requires educating clients, which is quite a task. Clients know mutual funds. Making the move to ETFs can raise the concern flag with clients. I made the move to ETFs in 2003 and 2004. The ETF universe was really getting started then so it was an undertaking teaching clients about ETFs. In fact, a client with about $2 million with our firm scheduled a meeting to essentially fire us due to our move to ETFs. He didn’t feel comfortable with them compared to mutual funds. He had other advisors who weren’t using ETFs and apparently frowned upon them. The day before the meeting, he read an article in an AARP publication about how ETFs were an institutional tool and the future of investing. We went from the firing line to being seen as cutting edge and sophisticated.
The second reason the move is slow is commissions. A large percentage of advisors are still paid with commissions, and ETFs don’t offer that 5% upfront payday for advisors. Hopefully, these advisors will become fewer and fewer over the years. Let’s also not forget that the mutual fund industry is going to put up a fight to keep their gravy train running. Not many ETFs would survive with the expense ratios of mutual funds. So I expect the fund universe to keep bad mouthing ETFs.
ETFdb: ETFs have received some bad press over the past few years. Have you had any bad experiences with ETFs that turned you off?
KK: I haven’t had a bad experience. Even the flash crash of May 2010 had no effect since it corrected itself. I don’t use limit orders so that kind of event shouldn’t affect my clients. One big complaint I hear from advisors is low volume in certain ETFs. Even in this situation, advisors can work with specialists that help market makers create or redeem the shares. It is the liquidity of the underlying holdings that is important, not the ETFs. This is one area of ETFs advisors are still ignorant.
ETFdb: Are there additional ETFs that you’d like to see launched? Or is the current lineup sufficient for your clients’ needs?
KK: I would like to see more precise bond ETFs. We are starting to see it already as iShares launched bond funds focusing on industrials, utilities, and other sectors. I would like to see the ability to buy a segment of the bond market such as short term utility company bonds or Australian long dated government bonds. I know this is difficult with liquidity of the bonds, but I am hoping that we continue to see the bond market(s) parsed in ETFs. On the equity side, I have enough ETFs on the market to satisfy the needs of my firm.
ETFdb: How long have you been using ETFs for? Do you see this product structure as the preferred means for building diversified, low-cost, long-term portfolios?
KK: Absolutely! I have been using ETFs almost exclusively since 2003. These vehicles are the best option for diversification, low-costs and tax efficiency. After 2008, I showed several prospects who were in mutual funds how they coughed up hundreds or thousands of dollars in capital gains even though their mutual funds were down 30% or more. It is eye opening for clients and prospects when they see this happen.
ETFdb: Aside from the well-known benefits offered through the ETF wrapper, what do you personally embrace about this product structure?
KK: I think transparency is the best trait of ETFs beyond the known low cost, diversification, and tax-efficient characteristics. People don’t trust Wall Street today. Having a product that is completely transparent as to how it operates, is valued, and its holdings is critical. People want to know a defined system exists for its operation, not activity behind a curtain.
ETFdb: What do you expect in terms of ETF adoption going forward? What types of investors have been slow to adopt or are potentially major beneficiaries of embracing ETFs?
KK: I expect ETF adoption to continue to explode. As the RIA community continues to take assets from the traditional brokerage world, ETFs will see an increase in assets under management. I also expect advisors to continue adopting ETFs. Numerous avenues exist to learn about ETFs that an advisor almost has to have his or her head in the sand not to pick up information on ETFs. One area that has been slow to adopt ETFs, in my opinion, is retirement plans. While tax efficiency wouldn’t apply in a 401(k) or 403(b) plan, the low cost and diversification benefits will appeal to these plans. With the new Department of Labor rulings requiring disclosure of fees starting this fall, I expect fees to take center stage in the retirement plan world, and companies offering ETFs will see a considerable uptick in business.
ETFdb: What are your thoughts on how the industry has evolved in the last few years? Going forward, what do you see as the potential growth areas for ETFs?
KK: The industry seemed to start as a boutique then grew into an experimental phase. By that, I mean ETFs started out with very broad based index products with only a few providers. Once assets accumulated, the experimental phase began with several ETF providers coming on scene with a multitude of ETFs. It felt like providers were throwing ETFs into the marketplace just to see which ones stick. While I think ETFs will still have some growing pains as each provider creates an identity, it seems like niches have been identified for providers. Product launches are also better thought out. I have had a few ETF providers talk to me about what I am looking for in ETFs and bouncing product ideas off of me.
We could still see another explosive experimental period if actively managed ETFs start to garner assets. That is an area for potential growth. From the consumer perspective, I think we will see more ready-made portfolio companies like Betterment that attract assets to ETFs. Also, the retirement plan arena will be another growth area for ETFs.
Bottom Line: The exchange-traded product structure will continue to attract self-directed investors and professional money managers who have been hesitant to change their ways as the ongoing education effort picks up steam and makes the cost, diversification, transparency, and tax efficiency benefits more well-known and better understood.