Versatile ETFs are Utilized in Many Portfolio Management MethodologiesPosted May 27th, 2011
Author: Jesse Mackey 
Why is this Topic Important to Wealth Managers? This blogticle represents part two a special series regarding advanced investing with ETFs. Recently there has been much discussion in the marketplace on the use of these tools and thus we present this topic for wealth managers who may consider these investment vehicles for their clients.
The existence of numerous disparate portfolio management methodologies in the institutional investment management world has not slowed the growth in popularity of Exchange Traded Funds (ETFs) and other Exchange Traded Products (ETPs) in the last several years. In fact, possibly the most convincing reason for the enormous popularity and success of ETFs is that they are so versatile. They are not designed for any one philosophy of investment, but can play a role in many different investment methodologies. Presented below are a few examples:
Passive Management Strategic Asset Allocation- For wealth managers and clients that use strategic asset allocation and adhere to a strict “Efficient Markets” view of the financial world, an entire diversified portfolio allocation may be built using ETFs, thereby minimizing costs/expenses to the investor, optimizing the transparency of the investment, and reducing risks associated with specific managers.
Active Management Strategic Asset Allocation- For wealth managers and clients that prefer to use actively managed components for the majority of the strategically allocated portfolio, they may also use ETFs to gain exposures to specific sectors that are not otherwise present in order to “round out” the allocation. They may also choose to use an ETF for the part of the portfolio devoted to the “efficient” markets, while the “inefficient” markets would be covered by an actively managed fund or separately managed account.
Tactical Asset Allocation and Absolute Return- ETFs have gained a great deal of popularity amongst wealth managers and clients that prefer to tactically shift the portfolio in anticipation or reaction to market events or other factors in an attempt to outperform the market. These investors are seeking to outperform (to the downside or the upside) not by selecting individual stocks or bonds, but by having an awareness and specialization in the qualitative/quantitative relationships between different areas of the market. ETFs allow them to have this specialization because they do not need to spend their time in finding stocks/bonds to fill out their allocation and can instead focus on inter-market relationship analysis.
Liability Driven Investing- The highly specific mandates/indexes associated with many ETFs mean that they are an excellent tool for Liability-Driven Investing (LDI). Passive Bond ETFs, industry-specific funds, leveraged ETFs, short ETFs, and the ability to buy/sell options on some ETFs make particularly attractive tools for this philosophy of investment, which focuses on hedging and insuring against risks as opposed to seeking risk-adjusted market returns.
Next week’s blogticles will present a discussion on wealth management and investing in tough economic conditions.
We invite your questions and comments by posting them below, or by calling the Panel of Experts.
 Jesse Mackey is the Chief Investment Officer of 4Thought Financial Group Inc. 4Thought is a boutique think tank created with the base vision of advancing individual freedoms and the human quality of life through economic means. This vision is pursued by applying the firm’s four specialties – Economic Theory and Research; Multi-Contingency Investment Management; Financial Planning for Business Owners and Individuals; and Support for Partner Firms and Advisors. You may contact Mr. Mackey at jmackey@4TFG.com or visit www.4TFG.com.