What advisors need to learn about ETF investing

Many advisors don’t have a clue on how to build a portfolio of ETFs or index funds

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When I began writing about investing, I was struck by the enormous gap between theory and practice. The overwhelming weight of academic research and real-world data make it clear that most investors who try to beat the market will fail. Whether they pick stocks, choose actively managed funds or try to time the markets, the majority would have been better off simply buying and holding a portfolio of ETFs or index funds. Yet many advisors seem unaware that indexing is even a viable option, let alone the one with the most evidence behind it. They’re like biologists who have never heard of Darwin.

I realize the main reason is self-interest. If you’re looking to attract clients, you sound much more impressive if you say you can deliver market-beating returns. And you can use that claim to justify higher fees. But there’s another reason indexing is rare among advisors: They’ve never been taught about its benefits.

This insight came to me over the last three years as I completed hundreds of hours of study to become, first, a licensed investment advisor and, then, to earn the Certified Financial Planner and Chartered Investment Manager designations. I learned a lot in these courses, but nowhere did I encounter the idea that advisors just might be better off recommending index funds.

Let’s start with the Canadian Securities Course (CSC), the first requirement on the way to becoming a licensed investment advisor or mutual funds dealer. Close to 400,000 Canadians have taken this Investing 101 since it was created in 1964. Browse the two-volume textbook and you’ll find an 18-page chapter on segregated funds, which are expensive insurance products with dubious benefits and a hefty price tag. There are 24 pages on hedge funds and 40 pages on derivatives. Meanwhile, the coverage of ETFs is barely five pages, and most is devoted to inverse and leveraged ETFs, which are purely speculative and represent a tiny portion of the market. For some advisors, the CSC will be the only investment course they take. Is it any wonder they have no clue how ETFs work?

If you think the material on indexing will come later in your education, you’d be wrong. One advanced course I completed last year included a lengthy section on how to estimate a resource company’s oil and gas reserves. It was followed by a chapter on technical analysis—a system for identifying patterns in the movement of stock prices that many portfolio managers consider as useful as astrology. A second course devoted 33 pages to how to market new investment products. Meanwhile, the material on ETFs and indexing was not just brief; some was flat-out inaccurate.

One textbook says Canadian equity ETFs do not include all of the stocks in their benchmark index because this would be “unwieldy,” “overdiversified” and “unnecessarily costly.” This is nonsense: All popular broad-market Canadian equity ETFs include all the stocks in their index and have for many years. Most of the material in these courses begins with the false premise that indexing results in mediocre performance and then explains in effusive detail how portfolio managers can do better by making tactical moves, clever trades, shorting stocks, using derivatives and a host of other exotic techniques, many of which have long fallen out of use. The subtext boils down to something like this: “Building a portfolio of ETFs for the long term is the work of simpletons. If you want to be a sophisticated portfolio manager, this is what you need to know.”

I don’t think I’m being naive. I’m not suggesting the curriculum for advisors should present indexing as inherently superior. This is not about replacing one dogma with another. New advisors should have an understanding of all popular strategies, including selecting individual stocks and actively managed funds. They should understand derivatives, segregated funds and hedge funds, even if they have no plans to ever use them in a portfolio.

But so too should all advisors have an understanding of ETFs, and they should have some exposure to the research highlighting the significant obstacles faced by active managers. Right now their education is full of misinformation that does a disservice to both the advisors and their clients.

There is some good news. More advisors are now focusing on financial planning in addition to simply recommending investments. Anyone working with real families understands that smart planning (which can include budgeting, savings strategies and tax strategies) is at least as important as choosing the right funds. The requirements for earning the Certified Financial Planner designation have recently become more rigorous too, which is likely to raise the level of professionalism in the industry. At least we’re moving in the right direction. Until then, new advisors have some homework to do.


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3 comments on “What advisors need to learn about ETF investing

  1. Here here! As a fee for service financial planner I always educate my clients on ETFs and index funds. They are always amazed at how much they’ll save on fees. When I wrote the CFA exams ETFs didn’t exist, but I am now studying for the CFP and am surprised how little information they cover on ETFs and passive investing. 1/2 a page on ETFs, seriously! Thank goodness for Moneysense Magazine, your couch potato blog and Morningstar as they are great sources of unbiased information.

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  2. Great article. Not to sound like a conspiracy theorist, but index-investing, using ETFs, completely undermines the CSC and CFA for students looking to become portfolio managers running $100MM+ discretionary books for their future brokerage employers. I just completed the PFP and it had the same shortfalls regarding ETF education. It is a shame.

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  3. Quick comment: “One textbook says Canadian equity ETFs do not include all of the stocks in their benchmark index because this would be “unwieldy,” “overdiversified” and “unnecessarily costly.”” is an awkward way to say that the ETF does not perfectly replicate the index (ie the tracking error). The famous SP 500 ETF from iShare, for example, holds equity from 511 firms and not 500 as one would expect from the SP 500. Otherwise, great article.

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