Are high-net-worth clients starting to prefer passive vehicles?

With more wealthy clients turning to ETFs, the active-versus-passive debate gets reignited

Are high-net-worth clients starting to prefer passive vehicles?
While high-net-worth (HNW) investors often construct portfolios with hedge funds, private equity, and customized blends of stocks and bonds, they have started shifting towards less specialized vehicles typically marketed to investors of more modest means: ETFs.

A late 2015 survey from Illinois-based Spectrem Group found that among respondents with $100,000 to $1 million in assets, 14% of their portfolios were composed of ETFs, according to the Globe and Mail. Among ultra-HNW investors – those with invested assets worth $5 million to $25 million – 43% held ETFs, up from 40% in the previous year.

While statistics are harder to find for Canada, Canadian advisors say wealthy clients are shifting to ETFs for various reasons including easier trading, diversification, and lower fees. “Much of [HNW investors’] interest in ETFs stem from the low fees, and in part that lows from the fact that a lot of active [mutual fund] managers have underperformed their benchmarks,” Nicola Wealth Management portfolio manager Ben Jang told the publication.

ETFs have become popular over the past decade because of the success of passive index-mirroring strategies, which most ETFs are built on. “But over the long term, focusing on quality companies is a better approach,” Jang said.

According to him, millennial investors are particularly keen on ETFs because many of them started investing after the 2008 recession, and therefore enjoyed the rise that came with the recovery since then. The Spectrem survey’s finding that younger wealthy investors hold ETFs in higher proportion than older investors do supports this.

But PWL Capital portfolio manager Graham Westmacott argued that HNW investors of all ages are looking for firms offering ETF-based portfolio management because they believe that passive strategies are superior. “There’s overwhelming evidence that over longer periods active managers will underperform their benchmark index and a comparable portfolio of ETFs,” he said.

Active managers don’t perform as well, Westmacott said, not just because of the higher fees they charge. “What we’ve seen over the past few decades is increased competition and professionalism among active managers,” he said, which makes it hard for them “to outperform.”

Susan Latremoille, a portfolio manager and head of a high-net-worth practice with Richardson GMP, had a different assertion: neither passive nor active investing is superior to the other. For instance, ETFs typically work well in providing exposure to the diversified and widely followed S&P 500 basket of stocks, but they may be less effective for the Canadian S&P/TSX Composite, which is weighted more toward energy and financial sectors.

Jang added that a potential weakness of passive investing is the risk of overconcentration due to indices being weighted toward the largest and most liquid companies. Furthermore, ETFs do not provide exposure to alternative investments favoured by HNW clients, such as private equity or real estate, which are higher-yield and typically do not correlate with equity and bond markets.

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