ETF’s reduce fees, but beware the risk of being robo’d away

In the post Royal Commission world of financial advice perhaps the biggest singular issue facing advisers is their ability to demonstrate adherence to best interest duties. This is not because most advisers don’t have their clients best interests at heart, but because often it’s very difficult to show that a strategy is the right one until after the fact. This is especially the case when it comes to investing, which inherently always involves an element of risk.

It is therefore unsurprising that many advisers are now choosing to focus purely on costs. With a beefed up regulator determined to take more aggressive actions on enforcement, this is an obvious path of safety, as cost is the one component of investing which can be determined with certainty before advice is provided. This is has led many advisers to abandon active management altogether and instead adopt portfolios made up of purely passive ETF’s. And why not? Supporting this choice is a wealth of information and research on efficient markets and the inability for large swathes of active managers to outperform their stated benchmarks.

Make no mistake, Resonant is a big supporter of the strategic use of ETF’s to gain low cost beta (market specific exposure) where appropriate. But we feel the argument above misses some key points. Especially that cost, while important, should not be the only consideration:

• Picking ETF’s is still active management – Generally, most retail investors will always require some form of asset class diversification. Given there is no worldwide benchmark for multi-asset portfolios, portfolio construction will always involve an element of active decision making. Underpinning this should be an ongoing analysis of the risks associated with each individual asset class, and their changing expected returns and correlations. While an Aus equities ETF, for example, may outperform an active manager vs the ASX200 index in isolation, other diversification or risk/return benefits for the overall portfolio may be missed.
• Portfolio management and advice should be integrated – The best investment solutions are those that tie in directly with the client’s stated goals and are realigned to adjust for those goals through time and changing market conditions. If an adviser steps back from playing any role in client portfolios, instead relying solely on low-cost passive solutions with static asset allocations, the question then arises as to whether the portfolio remains the most appropriate at all times.
• Advisers cannot compete on cost alone, attempts to do this may result in being “robo’d away” – Lastly, no business can avoid the fact that we live in a world where “disruption” is the new buzzword. Trying to compete with disrupters by mimicking their portfolios, but without their technology-driven pricing and scale, is a losing game. If you are not adding value outside of simply picking an allocation to ETF’s, how long before a client questions whether they should shift to a cheaper online robo-adviser?

For the reasons outlined above, Resonant favours a composite approach, where portfolios are constructed using a mix of low-cost ETF’s combined with additional holdings specifically selected to enhance the overall risk/return profile of the portfolio. In our view, portfolios like this can be constructed almost as cheaply as purely passive options, especially when direct equities are incorporated. Not only is this a sound approach to constructing portfolios, it also helps the adviser to retain and enhance their own value proposition.

Glen Holder
BCom, DipFP, MAppFin, CA
Director – Resonant

Nick Morton
MEng, MintBus
Director – Resonant