ETFs and the fee-based advisor

Not long after Andrew Pyle launched his fee-based advisory business eight years ago, he came to the conclusion that exchange-traded funds (ETFs) had an integral role to play in the construction of his clients’ portfolios. Pyle found that ETFs provide the flexibility to achieve the ideal asset allocation for his clients, and do so in a way that is both cost-effective and transparent.

“I do a lot of my own modelling, in terms of how much we want [to invest] in Canada [versus] how much we want outside of Canada,” says Pyle, senior wealth advisor and associate director, wealth management, with Pyle Wealth Management in Peterborough, Ont, which operates under the ScotiaMcLeod Inc. banner. “And ETFs are perfect for that.”

Pyle’s discretionary advisory platform is not focused entirely on ETFs. For example, he prefers to use individual stock selection for the Canadian equities portion of larger portfolios. But he does turn to ETFs primarily for the fixed-income and foreign equities portions of his clients’ portfolios, as well as for the Canadian equities portion of portfolios for smaller accounts.

“We’ll utilize ETFs where they offer value in a portfolio,” says Pyle, who began his career in financial services as an economist, serving most recently as vice president and head of capital markets research at Bank of Nova Scotia, before establishing his advisory business in 2007.

Pyle prefers to use plain-vanilla ETFs, such as iShares S&P/TSX Capped Financials Index ETF, in part because they are relatively easy for clients to understand – as opposed to using ETFs with more complicated leverage strategies, which can be confusing.

Ease of understanding also conforms to the rising demands from the financial services sector’s regulators that clients’ choices are clear.

“With the new suitability rules in place in the industry,” notes Pyle, “there is an even greater onus on the advisor to make sure that not only are the securities appropriate for the client, but that the client understands them, too.”

Organizing by sector

ETFs, particularly of the plain-vanilla variety, generally have the benefit of transparency compared with mutual funds, Pyle says. This benefit includes having a better idea of what securities an ETF holds at any given time, as well as the ability to know the value of the ETF at any particular time rather than having to wait for the once-a-day pricing of mutual funds.

Pyle favours ETFs organized by sector – such as iShares S&P/TSX Capped Energy Index ETF – or a combination of individual stocks and sector ETFs for the Canadian equities portion of portfolios for medium-sized accounts. This allows Pyle to maintain proper asset allocation, while allowing some customization.

“Given my own background [as a portfolio manager], I want to overlay [the asset allocation] with my own macro views of the market,” he says. “And you can do that with sector ETFs.”

For the fixed-income portion of his clients’ portfolios, regardless of asset size, Pyle relies almost exclusively upon ETFs, such as iShares Canadian Corporate Bond Index ETF. This is because of the flexibility these products offer for both moving from one type of fixed-income to another and moving in or out of positions altogether.

“Even the biggest pension fund [portfolio] managers are utilizing ETFs on the fixed-income front because of the liquidity issues we’re facing now in the bond market,” Pyle says. “In my portfolios, ETFs dominate the fixed-income space.”

Pyle also favours ETFs for the foreign equities portion of his clients’ portfolios, arguing that these ETFs provide his clients with an ideal way to achieve diversification while minimizing currency risk.

“Rather than go out and expose clients to currency fluctuations and trying to hand-pick 30 U.S. stocks, 30 European stocks and a bunch of emerging-market stocks with a relatively small number of ETFs, most of which are Canadian-dollar hedged, we can gain that foreign exposure in [clients’] equities portfolios,” he says.

Increasing foreign exposure

The growing popularity of ETFs also will help to continue the positive trend of Canadians gaining investment exposure outside of Canada, Pyle says: “Canadians still, on average, have an overabundance of exposure to the Canadian domestic market. Mutual funds got Canadians out of that a little bit, and I think [foreign equity] ETFs are kind of the next step.”

Pyle believes that the number of ETFs on the market, both plain-vanilla and more complex varieties, will continue to increase in popularity as investors seek out low-cost investment products and strategies.

However, Pyle also believes that financial advisors have a role to play in making sure ETFs remain cost-effective, so that clients continue to be well served: “It’s up to advisors collectively to make sure they’re putting as much pressure on the ETF industry to keep their costs under control as other parts of the financial services industry are putting on advisors to keep [our consulting] costs under control.”