For 25 years, Alan Gladstone picked individual stocks for clients. Then five years ago, Gladstone, a senior vice president and financial advisor for Morgan Stanley, began switching to exchange-traded funds. Today nearly all his client assets are in broad mixes of equity and fixed-income ETFs; he has no regrets about the change. “When you are a stock jockey, your accounts can have wild swings,” Gladstone says. “With the right ETFs, you can moderate the results, and clients are very happy with that.”

The Morgan Stanley advisor is hardly alone. A range of firms — including all the major wirehouses — are encouraging advisors to use ETFs — mainly index funds that trade on stock exchanges — as core holdings. With about $612 billion in assets, it's not news that ETFs are popular (indeed the mind reels at the number of offerings; see page 17). But the growing acceptance of ETFs among wirehouse advisors demonstrates how far they have grown professionally. These days, wirehouse-employed reps are “adding value as dynamic asset allocators and financial planners,” says Andre Cappon, a principal at The CBM Group, a financial services consultancy.

What a transformation indeed. Wirehouse advisors were once stock jockeys, peddling the favored stocks of the firm — as if one firm's analysts had some mysterious analytical edge on a stock that analysts in other office towers didn't. Then, seeking to unload the stock-picking responsibilities on third parties (because, in a downturn, you could blame the fund manager and keep your client), advisors turned to mutual funds (sometimes choosing their own firms' funds for the wrong reasons) and fee-based managed accounts.

Part of the fuel is the continuing focus on fee-based accounts. Also, advisors have recognized — as has a more sophisticated retail crowd — that very often active managers don't perform better than their benchmarks. “ETFs are a better tool for maintaining [client] relationships around market cycles,” Cappon says. Besides, too many funds charge too much for mediocre results. Using ETFs is a way to reduce clients' overall cost — without the FA taking a pay cut himself.

Strange Bedfellows

This has produced some interesting partnerships. Vanguard — a company founded with the express purpose of doing an end-run around FAs by delivering passive, low-cost asset management directly to individual investors (“built to put your interests first,” as its website crows) — began reaching out to financial advisors about five years ago. The marketing efforts have intensified in the past year as interest in ETFs has grown. “When brokers were focused on commission-based programs, they were not interested in no-load Vanguard funds,” says Martha Papariello, a principal in Vanguard's department that services financial advisors. “Now for many advisors, ETFs have become a good fit.”

Vanguard Group, the leader in retail index funds, says that $50 billion dollars of its ETFs are managed by advisors. Besides Vanguard, other ETF providers with sales forces that target advisors include Barclays Global Investors, State Street Global Advisors, WisdomTree Investments and Invesco PowerShares.

While the heaviest users of ETFs are fee-based advisors, commission-based accounts also hold the funds. Some advisors pick domestic stocks themselves and use ETFs for exposure to overseas investments such as emerging markets. With more than 600 ETFs available, it is possible to choose funds focused on, say, international real estate, or Brazil.

Smith Barney, a unit of Citigroup, now has $1.7 billion invested in its eight Select ETF portfolios. The all-ETF portfolios are broadly diversified, including growth and value shares, foreign and domestic, as well as stocks of all sizes. Typical holdings can include Vanguard Emerging Markets (VWO) and iShares Russell 1000 Growth Index (IWF). Smith Barney's moderate portfolio, which currently has 55 percent of assets in fixed income, could hold most of a client's portfolio. The aggressive choice, which only has 2 percent of assets in fixed income, is often used with other investments to build diversified portfolios. ETF Select also offers what it calls opportunistic purchases, short-term holdings that may include real estate or other assets that appear undervalued.

Advisors who want to mix ETFs with stocks or other choices can do so more easily now with the advent of unified management accounts at firms such as Merrill Lynch and Smith Barney. Using the new platforms, clients need only one account to hold a variety of investments, including separately managed accounts, mutual funds, stocks and ETFs.

“There has long been a debate about whether you should use active or passive investments,” says Marc Brookman, Smith Barney's director of product development. “We recommend a blending of the two. You should use ETFs or index funds wherever they are the most efficient choices.”

Popular ETFs on wirehouse platforms.

Name Ticker Inception Date Expense Ratio
Financial Select Sector SPDR XLF 02/98 0.24%
Technology Select Sector SPDR XLK 12/98 0.24
Vanguard Emerging Markets VWO 03/05 0.30
WisdomTree Emerging Markets High Yielding Equity DEM 07/07 0.63
WisdomTree Indian Earnings EPI 02/08 0.88