The ETF market is crowded, and advisors are looking for products that either fall into particular niches, or are low-cost core holdings. Either way, sponsors are working hard behind the scenes to differentiate their products. Those that do are seeing inflows.
Last year, three smaller operations among the top 20 ETF shops showed the biggest gains in assets under management: VanEck (AUM up 57.43%), Northern Trust’s FlexShares (up 55.08%) and Schwab (up 50.46%), according to Morningstar.
“What’s nice about FlexShares is that they are not the standard, typical ETFs,” says Joanne Woiteshek, a planner at Interactive Financial Advisors in Oak Brook, Illinois.
She particularly likes the FlexShares Morningstar Global Upstream Natural Resources Index Fund (GUNR, expense ratio 0.46%).
THE WATER ANGLE
The ETF’s 5% allocation to water resources, which Woiteshek considers an important category, was a factor in her choice. “GUNR is wonderful because somebody doesn’t have to buy a global water ETF,” she says.
The FlexShares ETF holds positions in five commodity groups: energy, agriculture, metals, water and timber. Because it concentrates on upstream assets, it avoids some of the more volatile portions of the commodity world, such as gasoline.
Even so, the ETF has experienced struggles along with commodities, and posted declines in 2014 and 2015.
“We didn’t pull back,” says Shundrawn Thomas, who heads the FlexShares business at Northern Trust. “What you saw in our product was strong relative performance. Smart advisors care about that.”
GUNR was the first FlexShares ETF for J. Christopher Cogswell, associate director of Portfolio Resources Advisor Group in Louisville, Kentucky. He likes that, with an upstream focus, the ETF is as close as you can get to natural resources without resorting to futures.
“It was a thoughtful design,” he says. “It made complete sense to me.”
Cogswell, whose firm packages portfolios for advisors, has since begun using the FlexShares Quality Dividend Index Fund (QDF, 0.37%) and the FlexShares International Quality Dividend Fund (IQDF, 0.47%). He explains that he is “trying to get income from as many asset classes as I can without chasing yield.”
THE INCOME CONSIDERATION
Income was a consideration for David Belding of Ascension Capital Advisors when he chose a VanEck Vectors ETF. The Houston-based wealth management firm uses the Fallen Angel High Yield Bond ETF (ANGL, 0.35%) as one of six equal-weight positions in its income portfolio.
Belding describes the ETF’s holdings as “the highest end of the high-yield space in terms of credit exposure.”
“This particular kind of debt is less duration-sensitive,” he adds, but volatility and income are not the only considerations. Because the ETF holds debt from companies that previously were investment grade, Belding foresees the possibility of capital gains.
“We see the potential for good business models that have historically had higher credit ratings to reclaim those at some point,” he says.
But why did Ascension pick ANGL over competing high-yield bond investments? “The unvarnished truth is we’re chart readers,” says Belding. “VanEck’s ANGL just gave us a superior read to other candidates in their peer group.”
ANGL is one of two VanEck ETFs currently being evaluated by Oatley & Diak, a family-run RIA in Parker, Colorado. John Diak, a principal at the firm, says he might use it as a tactical holding for clients who want to be more aggressive with their bond holdings.
Also under consideration is the VanEck Morningstar Wide Moat ETF (MOAT, 0.49%), which tracks an index of companies that Morningstar considers to have sustainable competitive advantages. Oatley & Diak began to consider ANGL and MOAT after a recent meeting with a VanEck wholesale rep.
Edward Lopez, head of ETF product management at VanEck, estimates that about 60% of his business is in the advisor channel. “We try to introduce our funds and see if it makes sense for them,” he says, adding that reaching independents can be a challenge.
Now that he has seen a presentation on VanEck ETFs, Diak thinks MOAT could be “paired with a traditional large-cap index fund to capture outperformance based on the strategy.”
‘IT COMES DOWN TO FEES’
There’s a good chance the large-cap index fund will be a Schwab ETF. “Quite honestly, it comes down to fees,” says Diak. “They are below all of their major competitors on cost. It aligns perfectly with us.”
Schwab is one of Oatley & Diak’s custodians, but the RIA spent a year or two evaluating Schwab ETFs after they were launched. “I’ve been impressed,” says Diak, who calls the Schwab lineup “pretty meat and potatoes.”
He is not the only advisor who considers cost when looking at core holdings. “We run all-ETF model portfolios,” says Nate Geraci, whose Overland Park, Kansas-based firm is appropriately named The ETF Store.
“We consider every ETF that’s out there,” he adds.
“We favor market-cap-weighted, low-cost ETFs,” says Geraci, a predilection that often leads him to include Schwab products in client portfolios. “Schwab ETFs are a very compelling option for core, broad-based exposure,” he says.
Schwab is one of two custodians The ETF Store uses for client holdings. Geraci notes that customers who use Schwab as a custodian can trade the firm’s ETFs commission- free.
“The trading platform can almost serve as a tie-breaker when you are looking at the different broad-based ETFs that are out there,” he adds.
Geraci may use five or six Schwab ETFs in a client portfolio, and include other ETF providers for niche exposure. Many of the specialty ETFs are available to his clients without commission, via Schwab’s ETF OneSource platform.
Don’t expect Schwab to launch niche ETFs anytime soon.
Don’t expect Schwab to launch niche ETFs anytime soon. Jonathan de St. Paer, senior VP at Charles Schwab Investment Management, explains that numerous competitors are adding smart beta and niche ETF products, but “we continue to see core products really driving asset flows.”
The company takes advantage of its size to deliver economies of scale. Schwab is a $3 trillion company, and CSIM manages some $300 billion. Its index business alone is some $120 billion, about half in ETFs.
“We think cost is really important,” says de St. Paer, who notes that the company goes to great pains to build efficiency into operations and sales. But the firm’s manufacturing capability doesn’t lend itself to building “smaller-scale, higher-cost niche products,” he adds.
