As ETFS gain steam, advisers follow along

Not only is the number of exchangetraded funds growing in Canada. So too are the ranks of advisers who specialize in putting together ETF portfolios.

They’re a new breed of advicegiver, serving those who have neither the time nor the inclination to make their own ETF buying decisions.

These advisers are known as ETF investment strategists, a description applied mostly to investment counsellors who serve high-net-worth investors.

A directory compiled by BlackRock Asset Management Canada Ltd., which manages the iShares family of ETFs, currently lists 11 ETF-strategies firms with a combined $3 billion in client assets. That’s undoubtedly only a partial list.

Building a portfolio of ETFs is similar to creating a mutual fund portfolio. Where low-fee index ETFs make a difference, however, is in making discretionary accounts more widely available.

These are accounts in which the investor signs off on an investment management agreement and leaves decisions on what to buy or sell to the adviser.

To offer discretionary accounts, advisers must meet higher educational standards and proficiency requirements than for ordinary accounts for which the investor must give permission for each buy or sell decision.

Typically, discretionary accounts require investors to put up at least $500,000, and it’s common for minimum account sizes to be set at $1 million.

By using ETFs, however, it has become economically feasible to offer discretionary investing at much lower asset thresholds, says Tyler Mordy of HAHN Investment Stewards & Co. Inc. in Toronto.

That’s because you don’t have to buy individual stocks and bonds one at a time to build a portfolio. In- stead, an ETF can provide one-stop exposure to a country, an industry sector or a commodity such as gold.

“What ETFs have done is open up asset classes previously available only to very large investors,” says Mordy, HAHN’s president and co-chief investment officer.

HAHN claims to have the lowest minimum account sizes on the Street for discretionary accounts: $100,000. Sure, that’s out of the reach of most younger investors or others of modest means. But it isn’t high-net-worth territory either.

A discretionary account is separate from those of other clients. This is advantageous for tax reasons.

With a pooled product like a mutual fund of funds, taxable capital gains may occur when the fund manager realizes profits by selling individual securities or rebalancing the fund’s holdings. These gains flow through to all holders of the fund, whether they want to take profits or not.

With a separately managed account, you have your own cost base for tax purposes and you and your adviser have control over when to take profits.

Nor would you be liable for capital gains within a pooled portfolio that were realized before you became an investor. “You’re not inheriting someone else’s capital gain,” says Mordy.

HAHN, founded by chairman and co-CIO Wilfred Hahn, has been creating ETF-only portfolios for upscale clients since June 2003.

During the 10 years ended June 30, returns on HAHN’s ETF portfolios — before fees — have been mostly in the range of 6 to 7 per cent annually. Fees, which are charged separately, bring these returns down significantly.

HAHN’s management fee is 1.5 per cent a year for clients with accounts ranging between $100,000 and $500,000. That covers custodial fees, but not trading costs or the management fees of the underlying ETFs.

When you add it all up, total ownership costs are in the 1.8 per cent range for HAHN’s entry-level clients.

That’s less than what is typical for adviser-sold mutual funds.

Fees are much lower for discretionary accounts that are in the seven figures or more. It’s the richest investors who get the biggest discounts on fees and earn correspondingly higher returns. More mutual fund columns by Rudy Luukko rudy.luukko@morningstar.com