Due Diligence: 8 Factors to Consider When Selecting an ETF Model Portfolio
With a number of model portfolios, specifically ETF model portfolios in the market, selection has become a more complex task.
In partnership with Greenwich Associates, we developed a comprehensive ETF due diligence framework to assist model portfolio selection and differentiate one provider from another.
State Street Global Advisors partnered with Greenwich Associates to conduct a study of ETF model portfolios and their users. Our goal was to gain a better understanding of what the investment community is looking for from their ETF model portfolio strategies and providers.
From this research, we developed a comprehensive ETF due diligence framework to assist ETF model portfolio users to differentiate between providers and select the best partner to achieve their goals. The eight elements of the framework are:
1. Investment Philosophy and Process
Clarity of investment philosophy and process is a critical consideration. Can the provider clearly articulate its philosophy? Is it easily understood? Ensure a provider can express its philosophy and process in a way that makes immediate and intuitive sense.
When evaluating an investment process, seek consistency and repeatability. The review should include a close look at how—and how well—providers design their ETF model portfolios. Even the best daily execution cannot overcome poor strategy.
Performance plays an important role in the decision-making process; noting attention should also be paid to how the performance is calculated.
Because calculating performance for portfolio components in aggregate can be complicated, most ETF model portfolio providers use some type of blended benchmark. A close examination of the blended benchmarks employed is an important part of due diligence. Buyers should also assess how well providers have achieved specific goals—such as delivering downside protection, upside capture and liquidity.
While pricing can be an important factor in provider selection, investors should look beyond overall pricing to factors that influence total costs. Pay close attention to fee structure, the complexity of which can sometimes significantly impact total costs for ETF model portfolio buyers. Moreover, investors should look at the fees relative to the strategy being provided, as strategy employed influences fees charged.
Investors should carefully evaluate the robustness of the provider’s infrastructure. Does the firm have sufficient staff, resources and capabilities in risk management, legal and compliance? Does the firm obtain designated resources to coordinate these functions and deliver a seamless solution?
5. Experience and reputation
There is wide variation among competitors in terms of experience, expertise and commitment to their ETF model portfolios. Large or small, providers need to clearly demonstrate their depth of knowledge and capabilities.
Buyers of ETF model portfolios should seek providers with a clear division of labour across functions. Having staff dedicated to investments, ETF selection, risk management, legal and compliance functions demonstrates that a provider has the expertise required to execute their strategies and support clients on a day-to-day basis.
How well does a provider communicate with clients? Seek a provider with a proven track record of timely, effective and thorough client communications. Providers should alert investors about any changes to the portfolio or underlying products, provide relevant updates about the firm, and supply market research and thought leadership.
Pay special attention to transparency in two key areas:
Performance Assessment and Reporting: As a best practice, buyers should have a standardised process for reviewing and assessing performance reports from all potential providers. Buyers should determine not only which benchmarks are used on the portfolio, but also why these benchmarks are used over others.
Conflicts of Interest: Conflicts of interest must be avoided at all costs, but it can be challenging in complicated portfolios with many underlying products and managers. Buyers of ETF model portfolios should seek out providers with clearly defined functions and reporting lines, reducing potential conflicts of interest within model portfolio teams. Buyers should additionally be wary of revenue-sharing agreements and should push providers to disclose any such arrangements.
Choosing an ETF Model Portfolios Provider
ETF model portfolios can be complex and have unique characteristics; it’s important to take into account all the value-add factors that result from this. Users of these strategies should remember they are not just buying a portfolio—they are also selecting a partner to support you and the portfolio over the long term. As a result, buyers of these products should rely on established best practices when implementing due diligence procedures for ETF model portfolios.
Between November 2016 and March 2017, Greenwich Associates conducted a study examining the ETF model portfolio space. Interviews were held with 90 key industry stakeholders including ETF strategists, investment consultants, national and regional broker-dealers, robo-advisors, and turnkey asset management programs (TAMP). Questions explored the dynamics that are driving growth in the segment and what methods of evaluation both advisors and investors currently leverage when selecting model portfolio strategies and providers.
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