Portfolio Perspective

Exchange-traded funds are the go-to investment choice of advisors: Survey

Key Points
  • New study finds advisors favor exchange traded funds for third year running.
  • 77 percent of advisors think blend of active and passive management delivers best performance, up from 64 percent last year and 57 percent in 2014.
  • More than half (52 percent) of advisor respondents are bullish on economy in near term, up from 26 percent in 2016.

Exchange-traded funds are continuing their reign as the go-to investment choice of financial advisors, but cash isn't far behind, according to a new study.

Released today by the Financial Planning Association, the 2017 Trends in Investing Survey shows that 88 percent of advisors either use or recommend ETFs and 85 percent turn to cash or cash equivalents.

While this is the first time the yearly survey shows cash beating out mutual funds (which are used by 80 percent of advisors), it marks the third consecutive year that ETFs are favored.

Which investment vehicles do you [as a financial advisor] currently use/recommend with clients?

Exchange traded funds88%
Mutual funds (non-wrap)80%
Individual stocks61%
Individual bonds52%
Mutual fund wrap program(s)33%
Variable annuities32%
Fixed annuities32%
Private equity funds15%
Hedge funds9%

"ETFs have gone from representing a very small part of [advisors'] tool kit to now representing a very significant part," said certified financial planner David Yeske, managing director of Yeske Buie.

"One of the things it suggests is that financial planners are ever more convinced that active management is hard," said Yeske, who helped develop the survey and interpret its results.

Unlike actively managed mutual funds — where a professional picks the individual holdings of a fund — ETFs track indexes, making them passively managed.

The survey also shows that 77 percent of advisors now think a blend of active and passive management delivers the best overall performance. That number stood at 64 percent last year and 57 percent three years ago.

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As for the increase in cash-type investments, Yeske said it could signal that advisors are taking a more conservative stance on the market.

"This makes me think that planners are feeling a sense of caution about the investment world and are building resilience in client portfolios," said Yeske, who worked on the survey in his role as an editor at the Journal of Financial Planning.

Advisors' use of cash has remained high following the 2008-2009 housing crisis and accompanying market nosedive. In the 2008 survey, before the crisis came to a head, 52 percent of advisors were using cash or equivalents. By 2010, that figure had jumped to 84 percent. The general trend since then has been a continued high use, although this year's figure of 85 percent is up from 74 percent a year ago.

The survey — a collaboration of the FPA, the Journal and Longboard Asset Management — also shows that half of responding advisors plan to increase their use or recommendation of ETFs over the next year. That's compared to 20 percent planning to increase their use of mutual funds and 19 percent for individual stocks.

Unlike actively managed mutual funds, ETFs track indexes, making them passively managed.
Daniel Fung | Getty Images

In 2006, the first year of the survey, just 40 percent of advisors reported using ETFs. By 2015, that had grown to 81 percent and took over mutual funds' position as the favorite investment of advisors.

CFP Douglas Kobak said he dedicates about 80 percent of his growth-oriented client portfolios to ETFs.

"They give me the flexibility to buy and sell during the day, I get transparency so I know exactly what's in the ETF, and the costs are low," said Kobak, a senior advisor and principal of Main Line Group Wealth Management.

Almost half (49 percent) of advisors cite lower costs as the biggest advantage of ETFs, followed by tax efficiency (23 percent) and trading flexibility (14 percent).

Portfolio diversification was explored for the first time in the survey this year, and it shows that 47 percent of advisors are looking for new ways to diversify client investments. Additionally, 27 percent say today's market conditions make diversification difficult.

Clients have to understand that diversity is more about achieving a certain amount of investment security and safety over the long-term.
David Yeske
managing director of Yeske Buie

Indeed, the performance correlation among different investments is higher than it used to be. Kobak said, for instance, that the performance correlation among U.S. large-cap, mid-cap and small-cap stocks is more than 90 percent.

"When you hit that level, the markets are all moving up and down together," Kobak said. "So what you used to be able to do to diversify in the 1990s, you can't do today."

Yeske at Yeske Buie said that, in the short-term, it's difficult to prevent portfolio volatility through diversification.

"No matter how you diversify, everything will move [up or down] together in the short run," Yeske said. "But clients have to understand that diversity is more about achieving a certain amount of investment security and safety over the long-term."

More than a third, 36 percent, of surveyed advisors question whether a traditional portfolio asset allocation of 60 percent stocks and 40 percent bonds can provide the same returns it has historically.

The biggest changes from last year in advisors' reasons for reevaluating their asset allocation strategy included inflation (40 percent, compared with 28 percent last year), anticipated changes to income taxes (35 percent versus 24 percent) and investment taxes (32 percent versus 21 percent).

Meanwhile, despite the increased use of cash or cash equivalents, 52 percent of advisors are bullish on the near-term economy. That's double the 26 percent who expressed such optimism in last year's survey. Just over a third of respondents (35 percent) are neutral in their outlook.

"I don't think there will be much movement in the market either way in the next six months," said Kobak of Main Line Group Wealth Management. "Until new information comes out about [potential] tax law changes, I think the market will stay in the range it is right now."

— By Sarah O'Brien, special to CNBC.com