Their low-cost attractions and easy access to market "Beta" keeps exchange traded funds center-stage in considering how portfolios are put together, a new study by Charles Schwab says.

More than two-thirds of wealth advisors polled recently by Charles Schwab Investment Management say that exchange traded funds make up the largest portion of clients’ core holdings. The data shows how these low-cost index-tracking vehicles are upending the investment landscape.

The survey of 381 independent advisors – each overseeing at least $50 million of client money – showed that ETFs account for 29 per cent of the “core” holdings of a portfolio, while individual bonds make up 18 per cent, individual stocks 25 per cent, mutual funds 24 per cent, and “other” covering 4 per cent. For the purpose of the survey, “core” covers mid- and small-cap equities, international stocks, and corporate and Treasury bonds.

Looking forward, 69 per cent of respondents said they expect that ETFs will account for more of how they carry out their asset allocations over the next five years, while 22 per cent say they will be unchanged and only 9 per cent plan to cut them. 

A bull market in equities lasting for almost a decade since the 2008 market crash has driven big growth in ETFs at a time when capturing the “beta” of the market for a low fee is seen as far more sensible than trying to beat a market that is rising anyway, and for a higher cost. Industry data shows that assets invested in ETFs and exchange traded products (these are similar to ETFs) that are listed globally amounted to $4.99 trillion at the end of Q2 2018, following net inflows of $85.47 billion and market moves during the period. In fact, ETFs globally hold more AuM than the hedge fund sector, at $3.24 trillion (source: ETFGI). Earlier this week, this publication reported on the Charles Schwab study of advisory firms’ market expectations.

ETFs on the march?
The ETF ascent has pressured traditional wealth management houses, benefiting firms such as BlackRock and Vanguard. Last year, renowned investor Warren Buffett told clients in his annual shareholders’ letter that hedge funds were not worth their fees when judged overall, and that clients should consider a tracker fund instead. 

The push into “passive” or index-tracking funds is not universally admired, not just because of how this is squeezing actively-run portfolios, but out of concerns that big AuM volumes in index-tracking funds distorts the market and impedes the ability of end-investors to engage in shareholder activism. (See articles on the issues here and here.)

On average, advisors say that 62 per cent of clients’ holdings should be allocated to core investments. More than one-third of advisors (38 percent) believe core has an even bigger place in client portfolios, saying that core should make up 70 – 100 per cent of holdings.

Among other findings in the Charles Schwab report was that the vast majority of advisors (86 per cent) said a clients’ level of wealth affects how much of their portfolio should be allocated to core holdings. Advisors, however, are split on what that threshold is, with 46 per cent saying that “mass affluent” clients (those with $100,000-$249,999 in investable assets) should allocate more of their portfolio to core holdings than “high net worth” clients (those with more than $1 million in investable assets) and 40 per cent saying the opposite.

A majority of advisors (66 per cent) said total cost is the most important consideration when choosing any index fund, whether it is a mutual fund or an ETF. Looking beyond cost, advisors say that when deciding between two funds that have the same investment objective and price, they look at performance history (58 per cent), track record (49 per cent) and an asset manager that provides great portfolio construction education and guidance (37 per cent).

When it comes to mutual fund investing, more than half of advisors (58 per cent) say that low or no minimums are very important when considering a fund. Forty-four per cent of advisors say mutual funds should have a single share class, accessible to all. Half of advisors believe that everyone should have the same access to the same lowest-cost funds, regardless of how much they have to invest.