Richard Ferri, the chief executive of Portfolio Solutions LLC in Troy, Mich., has been using exchange-traded funds since long before the hype. And though he has increased his exposure to the low-cost, tax-efficient investment products in recent years, he has avoided the newer ETFs that have become a fad.
"You do not need to beat the market by using fancy, expensive products," he said.
His portfolios have about 70% exposure to ETFs, versus 20% when Portfolio Solutions was started in 1999. State Street Global Advisors found in a March survey that only 12% of investment professionals had exposed 50% to 79% of their portfolios to ETFs.
Mr. Ferri said he has always liked ETFs for their low cost. They are heirs to an indexing tradition that began with institutional investors decades ago, when investors were encouraged to match the return in a given market. If he used all mutual funds with no ETFs in his portfolio, he said, the cost to the client would be about 0.3%; his heavy use of ETFs has enabled him to knock that down to around 0.2%, he said. As long as investment costs, taxes, and turnover remain low, he said, clients will be able to meet their long-term financial objectives. "The markets work well all by themselves."
Mr. Ferri's strategy enabled him to add roughly 100 clients last year, and his firm now has around 500.
It also has more competition. According to State Street's survey, all but 4% of investment professionals use ETFs, and wealth and asset managers, registered investment advisers and financial planners, and even the vast majority of bank professionals and broker-dealers are using them. As the prospect pool has expanded, new ETF products have been coming out that require more active management. "Right now we're not completely satisfied with some of the products," Mr. Ferri said.
For example, he said tax-free bonds tend to be underdiversified in an ETF structure, often containing only 25 or 50 individual securities. He prefers to invest in a municipal bond fund that might contain several hundred municipal bond investments.
When choosing ETFs, Mr. Ferri first considers the cost. If it is above 0.25%, he probably will not be interested in buying. Once he decides the cost is reasonable, he drills down to ensure he understands the securities in the fund.
Nearly 70% of the investment pros in the State Street survey said they thought the unknown, untested indexes and overwhelming number of choices in ETFs were one of the biggest drawbacks of such investing.
Mr. Ferri dismissed most products that have launched in recent years as "mere marketing."
"The people that are creating ETFs will say, We do this whiz-bang and backflips," he said. "I don't care. That's smoke."
About a year ago a salesman called Mr. Ferri and asked him why he was using products whose indexes were invented before television instead of modern ones built by computer models. "These old indexes are around because they work well and they do what they're supposed to do," he said. "It's hilarious to listen to these pitches."
Whether Mr. Ferri increases his exposure to ETFs further will depend on what new products come out,. He can see his firm increasing its exposure to 80% or 90%, though he said he is not sure it will ever get to 100%, since some mutual funds are still able to offer better deals.
Anthony Rochte, a senior managing director at State Street Global Advisors and the author of the survey, released in June, said he remembers selling Mr. Ferri some of his first ETFs eight and a half years ago. He said it is important for State Street to offer an array of ETFs. There have been a lot of product launches" from various firms — "some good and some not as good," Mr. Rochte said. "That's not going to prevent us from innovating where we know there's demand."
