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25.3.1 Exchange-traded Fund Wraps And Mutual Fund Wraps

A comprehensive guide to understanding exchange-traded fund (ETF) wraps and mutual fund wraps within managed accounts, explaining their structures, benefits, and management approaches.

25.3.1 Exchange-traded Fund Wraps And Mutual Fund Wraps

Exchange-traded Fund Wraps And Mutual Fund Wraps

The most basic services offered within managed accounts are exchange-traded fund (ETF) wraps and mutual fund wraps.

Exchange-traded Fund (ETF) Wraps

ETF wraps are often directed by a single portfolio manager who creates the model for a specific managed account.

The managed account holds a basket of ETFs for security selection. The underlying ETFs tend to be passive in their investment management, but the added value comes from asset allocation and geographic, currency, and sector selection. This extra service can follow either a passive or active approach.

Passive Approach

In a passive approach, the portfolio manager determines the client’s risk tolerance, sets the optimal asset allocation, and establishes the portfolio with ongoing rebalancing back to the set asset mix.

Active Approach

In an active approach, the portfolio manager determines the client’s long-term risk tolerance, applying a short-term tactical approach by actively overweighting or underweighting the sectors and asset allocation. The manager has greater discretion in rebalancing the portfolio to take advantage of changing market conditions.

Key Advantages of Active Management

  • Low Client Fees: The cost of underlying investment management is lower compared to other types of managed accounts.
  • Expert Evaluation: Portfolio managers provide expert evaluation of ETFs, determining which ones best fulfil the investment mandate.
  • Standardized Asset Allocation Models: Various models are available to meet different investor needs.
  • Hedging Abilities: There is a greater ability to hedge currency exposure within the portfolio.
  • Focused Advising: Since the portfolio manager researches and trades securities daily, advisors can focus more on financial planning, estate management, and wealth management services.
  • Marketing Support: Firms generally provide marketing support to their advisors.

Mutual Fund Wraps

Mutual fund wraps consist of a selection of individual funds managed within a client’s account or accounts. Unlike funds of funds, where investors hold units of the fund, mutual fund wrap clients hold actual funds within their accounts. Often, a separate account is established for the client in which the selected funds are held.

Management Structure

The composition and weighting of individual funds within the account are directed by an overlay manager. The investment management of the underlying funds is conducted by sub-advisors. Overlay managers play an active role by rebalancing the client’s holdings back to their target asset mix or by adding and removing funds based on the quality of the investment management and their views on the market.

Did You Know?

The overlay manager is essentially the portfolio manager of record, responsible for investing the assets, implementing the investment strategy, and carrying out day-to-day management of the portfolio.

Key Advantages of Mutual Fund Wraps

  • Coordinated Investment Account: An account optimized for asset allocation and selection of managers.
  • Standardized Asset Allocation Models: Available to meet various investor needs.
  • Currency Hedging: Ability to hedge currency exposure within the portfolio by choosing hedged or unhedged mutual funds.
  • Ongoing Oversight: Continuous management oversight of the selected funds.

Glossary

  • Exchange-Traded Fund (ETF): A type of security that tracks an index, commodity, bonds, or a basket of assets like an index fund. Unlike mutual funds, ETFs trade like a common stock on a stock exchange.
  • Overlay Manager: The person or group responsible for the overall investment strategy and day-to-day portfolio management within mutual fund wraps.
  • Passive Management: An investment strategy that aims to replicate the performance of a specific benchmark or index.
  • Active Management: An investment strategy where the manager makes specific investments with the goal of outperforming an investment benchmark index.
  • Asset Allocation: Strategy of dividing investments among different asset categories, such as stocks, bonds, and cash, to optimize risk and return.

Key Takeaways

  • ETF and mutual fund wraps are basic services in managed accounts offering different approaches (passive vs. active) and benefits.
  • ETF wraps generally hold a basket of ETFs and gain added value from smart asset allocation, with low client fees and a variety of asset models.
  • Mutual fund wraps involve actively managed individual funds within a client’s dedicated account, directed by an overlay manager for an optimized asset allocation and currency hedging.
  • Both services allow investors to diversify and hedge risks effectively while benefiting from expert management.

FAQs

Q1: What is the main difference between ETF wraps and mutual fund wraps? A1: The primary difference lies in the type of assets held and the level of management. ETF wraps hold a diversified basket of ETFs and lean towards asset allocation strategies, while mutual fund wraps involve individual mutual funds managed within a client’s account by an overlay manager with active management strategies.

Q2: How do ETF wraps benefit clients? A2: Clients benefit from relatively low fees, expert management and evaluation of ETFs, various asset allocation models, and the ability to hedge currency exposure, allowing advisors to focus more on other areas like financial planning.

Q3: What role does an overlay manager play in mutual fund wraps? A3: The overlay manager is responsible for the overall coordination and optimization of the client’s portfolio, including reallocating assets to align with investment goals and current market conditions.


📚✨ Quiz Time! ✨📚

🧐 Assess and Solidify Your Understanding

Welcome to the Knowledge Checkpoint! You’ll find 10 carefully curated quizzes designed to reinforce the key concepts covered. These questions will help you gauge your grasp of the material, identify areas that need further review, and ensure you’re on the right track towards mastering the content for the Canadian Securities certification exams. Take your time, think critically, and use these quizzes as a tool to enhance your learning journey. 📘✨

Good luck! 🍀💪

## What is one key difference between ETF wraps and mutual fund wraps? - [x] ETF wraps are often directed by a single portfolio manager, while mutual fund wraps are directed by an overlay manager. - [ ] ETF wraps use active management only, while mutual fund wraps use passive management only. - [ ] ETF wraps involve holding actual funds, while mutual fund wraps invest in a fund of funds. - [ ] ETF wraps have high client fees, while mutual fund wraps have low client fees. > **Explanation:** One key difference is in the management structure: ETF wraps are typically managed by a single portfolio manager while mutual fund wraps are managed by an overlay manager. ## In an ETF wrap, what does the portfolio manager primarily add value through? - [ ] Selecting the individual stocks within the ETFs. - [ ] Consistently timing the market. - [x] Asset allocation and sector, geographic, and currency selection. - [ ] Eliminating all hedging strategies. > **Explanation:** The portfolio manager adds value primarily through asset allocation and geographic, currency, and sector selection rather than selecting individual stocks within ETFs. ## What is a key advantage of the active management approach in ETF wraps? - [ ] Higher client fees. - [ ] Minimal rebalancing of the portfolio. - [ ] Limited selection of asset allocation models. - [x] Greater discretion to rebalance the portfolio to take advantage of changing market conditions. > **Explanation:** The active management approach allows the portfolio manager greater discretion for rebalancing the portfolio in response to changing market conditions. ## How do mutual fund wraps differ from funds of funds? - [ ] Mutual fund wraps have higher fees than funds of funds. - [x] Clients hold the actual funds within their account in mutual fund wraps, while in funds of funds, clients hold units of the fund of funds. - [ ] Mutual fund wraps are managed by sub-advisors, while funds of funds are managed by a single manager. - [ ] There is no active management in mutual fund wraps, while funds of funds always involve active management. > **Explanation:** In mutual fund wraps, clients hold the actual funds within their account. In funds of funds, clients hold units of the overarching fund that in turn invests in other funds. ## Who is responsible for the ongoing management and rebalancing of mutual fund wraps? - [ ] The client. - [ ] The financial advisor. - [x] The overlay manager. - [ ] The sub-advisors. > **Explanation:** The overlay manager is responsible for the ongoing management, rebalancing, and selection of funds within mutual fund wraps. ## What is one advantage of having an overlay manager for a mutual fund wrap? - [ ] Reduced ability to hedge currency exposure. - [ ] Limited models for asset allocation. - [ ] Higher client fees compared to other managed accounts. - [x] Coordinated investment account optimized on asset allocation and selection of managers. > **Explanation:** The overlay manager coordinates the account to optimize asset allocation and the selection of fund managers. ## What role does ongoing rebalancing play in ETF wraps with a passive approach? - [x] It maintains the optimal asset allocation based on the client's risk tolerance. - [ ] It aims to constantly change asset allocation in response to market trends. - [ ] It minimizes the need for asset allocation changes. - [ ] It reduces the overall investment returns. > **Explanation:** In a passive approach, ongoing rebalancing helps maintain the optimal asset allocation set according to the client's risk tolerance. ## Why might an advisor prefer to work with ETF wraps or mutual fund wraps? - [ ] To focus solely on selecting individual securities. - [ ] To minimize client fees. - [ ] To manage all financial planning on their own. - [x] To allocate more time to financial planning, estate management, and other wealth management services. > **Explanation:** Working with wraps allows advisors to focus more on broader aspects of wealth management, as the actual investment management is taken care of by portfolio managers and overlay managers. ## Which wraps allow for both hedged and unhedged options to manage currency exposure? - [ ] Only ETF wraps. - [ ] Neither ETF wraps nor mutual fund wraps. - [x] Both ETF wraps and mutual fund wraps. - [ ] Only mutual fund wraps. > **Explanation:** Both ETF wraps and mutual fund wraps offer the ability to manage currency exposure through the choice of hedged or unhedged options. ## What is a key cost advantage of the active management approach in ETF wraps? - [ ] All associated fees are higher. - [ ] Management fees are consistent regardless of the underlying investments. - [x] Client fees are relatively low because of the lower cost of managing the underlying ETFs. - [ ] There is no added value from the portfolio manager's expertise. > **Explanation:** The lower cost of managing the underlying ETFs in an active management approach typically results in relatively low client fees.

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Saturday, July 13, 2024