Facing a Massive Menu of ETFs? 4 Steps for Smart Choices

Written by: Jillian DelSignore , Head of ETF Distribution at J.P. Morgan Asset Management

The Cheesecake Factory opened its first New York City location back in November, and it was met with unexpected enthusiasm. Who would have thought that in a city known as the home of many of the world’s top-rated restaurants—where food is as much an art as a pastime—a monstrous chain like The Cheesecake Factory would draw three-hour-long lines? The simple answer: choice. The enormous, spiral-bound menu boasts pages and pages with enough gastronomic options to ensure that even the pickiest eaters in your party will find something to feed their cravings. And yet, facing so many choices, deciding what to order can be more than a little overwhelming.

In the world of ETFs, advisors face a similar challenge. Simply put, the menu of ETFs is massive. And while advisors used to debate only about the merits of active versus passive investing, the recent growth of the ETF market has fundamentally changed that conversation to include every strategy under the sun: active vs. passive, strategic beta vs. market cap, single factor vs. multi-factor…the list goes on. So when your goal is to add low-cost, transparent, liquid products to your portfolio—and the menu includes more than 2,000 options to choose from—where do you even begin?

As with any type of investing, it’s critical to take the time to identify your goals before you begin. What are you trying to achieve by adding an ETF to the portfolio? What exactly are you seeking to achieve with your exposures? Once that’s clear, the following four steps can help you evaluate your investment options and make the best possible choices for your portfolio.

Step 1: Choose a sponsor that shares your values—and adds value to the process.

If your goal is to select an ETF based on your clients’ needs, working with a sponsor that offers experience in investment management can go a long way toward helping you understand the “why and how” behind each choice, rather than just the mechanics of the product design. A sponsor that is also working in your clients’ best interests will be vested in helping you make optimal selections, as well as educating your clients on how the ETF you’ve chosen can help support their goals.

Step 2: Explore exposures.

There was a time when the majority of ETFs all offered similar exposures. But now that there are so many new and diverse options, it’s easy to miss unforeseen risks unless you take the time to understand how the underlying index is constructed and how that drives performance. How are securities selected? How are weightings assigned? What’s the potential for sector or stock biases? Indexes have evolved along with the industry, and it’s important to understand the implications of each type of construction and whether or not it aligns with your investment objectives. Look at all your options, be sure you understand the pros and cons, and choose what’s best for the portfolio.

Step 3: Consider liquidity.

Start with the understanding that trading volume does not equal liquidity. Every ETF holds a basket of securities, which means the liquidity of the ETF, depends not on one stock, but on the liquidity of all underlying holdings. It’s critical to understand if and when you can trade, and at what cost. Because liquidity isn’t always easy to determine, work with the issuer’s Capital Markets desk to answer your questions and guide you through the trading process. Ask specific questions—“If I placed a $10M trade, what impact would that have on the portfolio?”—and demand clear answers to help you make the best possible decision.

Step 4: Scrutinize costs.

While ETFs are renowned for their low fees, the total cost of ownership for an ETF is about much more than the fund’s expense ratio. To be sure you’re considering all aspects of cost, look closely at tracking error and how consistently the ETF moves with the index. Analyze live track records or compare a back test to the live track record history. Pay attention to bid/ask spreads, rebalancing costs, brokerage fees, and capital gains. Every additional cost impacts the total investment cost and, ultimately, the total value of the fund within the portfolio.

As the ETF market continues to evolve, your knowledge needs to evolve as well. By completing the necessary due diligence—either on your own or with the help of a trusted partner—you can sift through the massive menu in front of you and make choices that not only leverage the inherent value of ETFs, but also deliver the right strategy at the right time to help address your clients’ investment goals. The end result is likely to be much more satisfying than that slice of White Chocolate Caramel Macadamia Nut Cheesecake you’ve had your eye on. Here’s to smart choices!

Learn more about ETF due diligence at: www.jpmorgan.com/etfs

Opinions and statements of market trends that are based on current market conditions constitute our judgment and are subject to change without notice. These views described may not be suitable for all investors. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations. Past performance is no guarantee of future results. Investment returns and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. ETF shares are bought and sold throughout the day on an exchange at market price (not NAV) through a brokerage account, and are not individually redeemed from the fund. Shares may only be redeemed directly from a fund by Authorized Participants, in very large creation/redemption units. For all products, brokerage commissions will reduce returns.
J.P. Morgan Asset Management is the marketing name for the asset management business of JPMorgan Chase & Co. and its affiliates worldwide. J.P. Morgan Exchange-Traded Funds are distributed by SEI Investments Distribution Co, One Freedom Valley Dr., Oaks, PA 19456, which is not affiliated with JPMorgan Chase & Co. or any of its affiliates.
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