Wrapping up the Exchange-Traded Funds Business

The competition over exchange-traded funds wraps is heating up. Three of Wall Street’s largest wirehouses—Merrill Lynch, Smith Barney and UBS—have over the past 12 months joined a generally limited field offering the wraps.

The competition over exchange-traded funds wraps is heating up. Three of Wall Street’s largest wirehouses—Merrill Lynch, Smith Barney and UBS—have over the past 12 months joined a generally limited field offering the wraps.

The popularity of ETFs is the starting point for packaging the funds, but the wraps come with their own advantages. They advance Wall Street’s strategic move away from commission income because investors are charged a fee for the wraps. ETF wraps are also thought to be good for investors because they’re cheap and represent an easy way to diversify a portfolio.

“They’re great for all kinds of clients because you can slice and dice the asset allocations more finely than with a separately managed account,” says Greg Ehret, co-head of the advisor strategies group at ETF giant State Street Global Advisors, which helped Merrill and UBS roll out their ETF wraps last year.

Assets and flows into ETF wraps are hard to track at this early stage, say analysts and industry executives, but anecdotally, they claim everyone is getting on board. “There’s been a tremendous amount of interest in them,” says FRC analyst David Haywood. “Portfolio construction is starting to get more sophisticated, and ETFs are very valuable tools to use in portfolio construction—you can get a number of various very specialized sector ETFs these days.”

A.G. Edwards, the pioneer in the ETF wrap business, just launched its 27th ETF wrap—called the Laffer Global ETF Portfolio—at the end of January. The Laffer ETF wrap will hold a number of international ETFs, selected using the international research of acclaimed economic research and consulting firm Laffer Associates (Dr. Arthur Laffer was a member of President Reagan’s Economic Policy Advisory Board for the president’s two terms). While most of A.G. Edwards’ ETF wraps are put together by its own internal investment advisory committee, it also relies on third-party advisors.

Other firms that currently offer ETF wraps include Raymond James, Morgan Stanley and Fiserv, which uses managed ETFs in retirement plans. “[ETF wraps] are continuing to be launched by regionals as well as wires,” says Ehret. “We’re seeing increased activity across the board. ETFs are very well positioned for wrap programs—they are low-fee products, they’re very flexible—they cover so many different pieces of the market,” he says. “It allows advisors to add value through asset allocation through all the choices. If you went back five years ago there just wasn’t the selection.”

A record-breaking 51 new ETFs hit the market in 2005, according to Morningstar. Today there are ETFs tracking everything from fixed-income to mid-cap growth stocks to homebuilders to currencies. Total ETF assets were $301.4 billion at the end of 2005, compared to just $247.7 billion the year before, or a gain of more than 20 percent, according to data from Strategic Insight, which follows over 150 ETFs. Barclays Global Investors is the leader by far in the business, with $170.6 billion in ETF assets. State Street is the next largest player in the business, with $80.3 billion in ETF assets.

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