ETF managed portfolios, investment vehicles that typically have more than half their assets in exchange traded funds, are one of the fastest-growing areas in the separately managed accounts business. Total assets in the ETF managed portfolios tracked by Morningstar are up 37% since September 2012.
More advisers are using ETFs instead of individual stocks and bonds as portfolio building blocks. This allows the manager to focus on entire sectors rather than individual companies, for example. Also, ETFs generally have low management fees and tend to be liquid and easily traded.
Rick Dworaczyk, chief investment officer of Texas-based Foresight Financial, is among the new breed of investment managers who are using ETFs to construct client portfolios.
Dworaczyk oversees the new Lower Volatility Returns Portfolio on the Covestor platform.
Currently, the portfolio’s largest individual holding is Vanguard Small-Cap ETF (VB).
Dworaczyk says small-caps are more of a play on the U.S. economy since large-cap stocks are multinational corporations that generate a higher percentage of revenue in international markets.
“I like U.S. small-caps as a core holding,” the portfolio manager said. “They tend to have higher volatility than large-caps but also tend to outperform large-caps over longer periods.”
Overall, Lower Volatility Returns portfolio tries to outperform the S&P 500 (SPX) over longer periods with lower risk, using a rules-based approach.
Dworaczyk said the strategy is quantitative and that the portfolio can invest across multiple asset classes. For example, he has positions in some developed European markets through iShares MSCI Netherlands ETF (EWN), iShares MSCI Belgium Capped ETF (EWK) and Global X FTSE Nordic Region ETF (GXF).
“There has been a lot of focus on the troubled Eurozone nations such as Portugal and Greece,” Dworaczyk said. “However, Northern Europe looks attractive and these markets have good long-term performance.”
Among U.S. sectors, he owns SPDR S&P Insurance ETF (KIE).
“Within financials, bank stocks still have a lot of issues and regulatory risks,” Dworaczyk said. “I see insurance as more stable with less regulatory risk. I feel it’s a better place than banks to position for the continued recovery of the U.S. financial sector.”
Lower Volatility Returns Portfolio also has a position in real estate investment trusts via Vanguard REIT ETF (VNQ).
“REITs have a lower correlation to the S&P 500 and other U.S. large-cap benchmarks, so they can be a diversifier,” Dworaczyk said. “REITs have underperformed lately due to concerns over rising interest rates, but the fundamentals and valuations look attractive.”
DISCLAIMER: The investments discussed are held in client accounts as of January 31, 2014. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. ETF shares trade like stocks, are subject to investment risk and will fluctuate in market value. Past performance is no guarantee of future results.
