How to Use ETFs in a Portfolio

Broaden Asset Allocation

ETFs offer investors a sophisticated tool to gain exposure to broad and targeted market segments covering a wide range of asset classes, equity market capitalisations, styles, and sectors. This enables investors to build customised investment portfolios consistent with their financial needs, risk tolerance, and investment horizon.

Strategic Asset Allocation

Strategic asset allocation is a target allocation of asset classes you expect to have in place for a long period of time. The target allocation is expected to remain the same and the portfolio is rebalanced to the original allocations when they deviate significantly from the initial settings due to differing returns from the various assets. Strategic asset allocation looks more at the overall risk objective of the portfolio, and therefore takes a long-term view.

Whether you’re looking to cover the broad global equity market, the total bond market, or take positions in specific countries, commodities or real estate, there’s likely an ETF – or ETFs – to help meet your objectives.

Tactical Asset Allocation

Tactical asset allocation is a short to intermediate-term view that looks for investment opportunities in the market. It allows investors to make real-time adjustments to their long-term asset allocation to take advantage of short-term tactical opportunities.

Tactical adjustments might include increasing allocations to markets and sectors that have become more attractive, or decreasing exposures to less attractive ones. Investors can also easily reverse these tactical moves once the opportunities and risks have run their course.

ETFs are an efficient tactical asset allocation tool as they offer intra-day trading at typically lower costs.

Core-Satellite Strategies

A core-satellite strategy seeks to replicate the broad market return in the “core” portion of a portfolio, and uses a “satellite” strategy to find alpha opportunities and add diversification using non-core market exposures.

Broad, market-based ETFs can be used as the core of an investment strategy. Sector, commodity-based, or other smart beta or active ETFs can be used to add a cost-effective satellite strategy to a portfolio to complement the “core.” This approach allows an investor to customize their exposure and risk to potentially enhance returns.

Access Hard-to-Reach Markets

ETFs have democratised investing, giving individual investors the same access to investment solutions as institutional investors.

The ETF wrapper has opened up new doors to:

• Emerging markets
• Fixed income
• Commodities
• Currencies
• Managed portfolios
• And many more

ETFs offer expanded market exposures in a convenient, portable investment instrument.

Portfolio Management

There are a number of portfolio management options using ETFs:

• ETFs are a helpful tool for rebalancing portfolios and keeping them on track to meet long-term strategic asset allocation targets.
• ETFs can easily be used to refine portfolio strategy and adjust holdings in response to shifting market conditions or an investor's changing needs.
• Year-end can be an apt opportunity to rebalance portfolios while taking advantage of possible unrealised losses.

Risk Management

The broad array of ETFs available today creates risk management approaches for individuals and smaller institutions that only large institutional investors could access previously.

For example, sector ETFs can also be a useful tool for investors, allowing them to hedge their individual stock investments by effectively diversifying their risk exposure across the broader equity market.

Tax Management

ETFs can be easily employed to help investors minimise their tax consequences. Because ETFs usually track market indexes, turnover is generally low. Typically, lower turnover results in fewer capital gains and thus lower taxes. Investors typically don’t realise capital gains from other unitholder redemptions.

Transition Management

When investors change asset managers, they’re often concerned with how to preserve equity exposure during the transition. One way to achieve this goal is to liquidate the portfolio and then re-invest the assets in an ETF with a high correlation to the benchmark of the active manager. Once a new manager is chosen, the investment professional can sell the ETF shares to fund the purchase of this exposure.