Managed US ETF Assets Surge
Thursday, January 26, 2012

Total assets in United States exchange traded fund managed portfolio strategies rose by 43% in 2011, according to a new report by Morningstar.

Morningstar's ETF Managed Portfolios Landscape Report, which explores current trends, asset growth, and the industry outlook for ETF managed portfolios estimates that the total amount of ETF managed portfolio strategy assets in the US now stands at somewhere between USD40bn and USD100bn.

According to the report, the space is currently dominated by global strategies (defined as strategies where investors can gain exposure in any global market), which hold more than 72% of all ETF managed portfolio assets). The subset of Global All-Asset strategies, which have the ability to invest in multiple asset classes, has captured more than half of the asset growth in ETF managed portfolios over the past year

An important factor driving growth says Morningstar is the trend for financial advisors to outsource money management functions to firms specializing in ETF managed portfolio strategies, which allows advisors to focus on managing clients’ overall financial profiles.

Andrew Gogerty, Morningstar’s ETF managed portfolios strategist and the author of the report, said: “As more investment professionals become familiar with ETF managed portfolio strategies, we expect demand for information to increase, and our goal is to provide the industry standard for classifying and comparing these strategies. By providing insight into a strategy’s attributes, we want to help advisors and institutional investors better understand the investment philosophy behind a particular strategy.”

First listed in the US in 1993, and in Europe in 2000, an ETF is an investment company with shares which trade intraday on stock exchanges at market-determined prices. Investors can buy and sell them in the same way as they currently trade in equities on an exchange. ETFs have become ever more popular due to their lower transactions costs and flexibility.

A 2011 report by BNY Mellon and Strategic Insight predicted that the total US ETF market could be worth USD2 trillion by 2015, with demand driven by new asset classes, new indexes and new ways to use ETFs as tools for portfolio construction.

In a separate report, Morningstar examined the tax efficiency of ETFs by measuring the frequency of capital gains distributions of ETFs compared with indexed open-end mutual funds over the past five, 10, and 15-year periods. The report found that most ETFs are indeed tax-efficient compared with open-end funds, and the primary driver of ETFs’ tax efficiency is that most ETFs are passively managed index funds. ETFs also generate a smaller, but still significant tax savings from their structure—in the event of redemptions, ETFs help minimize taxable capital gains through the ability to exchange securities in-kind.

However, the report also found that tax efficiency is only one small component of after-tax performance: expense ratios, tracking error, index methodology, and replication methods may have an effect on returns that exceed any tax benefit. In addition, investor behavior, including managing allocations and minimizing turnover, are far more important than the tax structure of an investment vehicle when determining long-term performance.

Paul Justice, Morningstar’s director of ETF research, North America, said: “We wanted to test the tax efficiency claims that ETF providers have boasted about for years, and it turns out their claims are largely true. However, most passive mutual funds are extremely tax efficient as well, and when all efficiency factors outside of the tax question are put into play, we find that fund structure plays only a small role.”