Advisors tilt toward ETFs, growth stocks and investment-grade bonds: Fidelity

The multiyear trend favoring exchange-traded funds over mutual funds is on full display in the latest Trends in Portfolio Construction report from Fidelity Investments.

A preview of the second-quarter report, which will be released later this week, shows the average financial advisor has 26% of his or her model portfolio invested in ETFs, up from 18% two years ago.

Other key trends in the quarterly research, which analyzed 2,100 professionally managed investment portfolios, included more aggressive allocations on the equity side and more conservative fixed-income weightings.

Paul Ma, lead portfolio strategist at Fidelity Institutional, said the growing appeal of ETFs over mutual funds can be attributed to a one-two punch that initially included a growing appetite for passive over active strategies, then was boosted by the increased access to actively managed ETFs, which are now attracting advisors who want active strategies.

“ETF use is getting really high,” Ma said. “The traditional benefits of ETFs being cheaper, more tax-efficient and having daily liquidity have always helped make ETFs more appealing to financial advisors.”

Randy Burns, founder and senior financial planner at Model Wealth, said the transition to ETFs was a no-brainer for his practice.

“We’ve switched almost entirely to ETFs for our recommendations as they trade commission-free at all the major brokerage firms and their intraday trading allows for immediate confirmation that rebalancing is successful,” Burns said.

Seth Mullikin, founder of Lattice Financial, has primarily used ETFs for client portfolios since he started his firm almost three years ago.

“Their main benefits are tax-efficiency and low cost,” he said. “ETFs rarely distribute capital gains, meaning they are more tax-efficient for investors in nonqualified accounts.”

It’s a similar story for Kevin Brady, vice president at Wealthspire Advisors.

“ETFs have been the go-to option for equities in our client portfolios for some time, and I’m specifically referring to passive equity ETFs,” Brady said. “At least for passive equity, it is difficult to find the same advantages within a mutual fund, outside of Vanguard, which offers index mutual funds mirroring their ETFs.”

Looking beyond the investment wrappers, the report also highlights a unique allocation balance that shows average large-cap growth equity weightings across the studied portfolio models at 37%, compared to 24% for large value and 39% for core equity.

“This is the highest we’ve seen the large growth allocation in the last few quarters,” Ma said. “We’re also seeing cash positions that are still really high, but the value-growth question is really tilting toward growth.”

Paul Schatz, president of Heritage Capital, said the more aggressive equity weighting lines up with his outlook for stocks.

“For more than nine months, I have pounded the table about the new bull market,” he said. “As in the past, you typically don’t see advisors changing behavior until some fundamental event changes the landscape. In this case, the soft landing has replaced recession. Inflation has moderated.”

On the bond side of the portfolio, Ma said, “advisors are fully on board the fixed-income train,” but in a more conservative way.

“The investment-grade allocation within fixed income is at a two-year high of 79% and long-duration bonds have increased consistently quarter-over-quarter to 5.8%,” he added. “Advisors are taking more risk on the equity side but on the fixed-income side they’re hedging their risk.”

Tim Holsworth, president of AHP Financial, admits to following that model, but he thinks of his bond strategy less as hedging and more as taking what the market is giving.

“On the fixed-income side, everyone is assuming rates will go down next year,” Holsworth said. “There’s no reason to go high yield because the rates are so high on the investment-grade side. If you can get 5% in a money market, how much risk do you want to take to get 6% or 7%?”

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