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Advisers Favor ETFs, Retract From REITs

Advisers this year remain enthusiastic about exchange-traded funds, but reticent when it comes to real estate investment trusts (REITs), according to a survey of independent investment advisers surveyed by Charles Schwab Institutional of San Francisco.

That means that wholesalers and manufacturers of both types of products have to hone their messages in order to tap into this powerful network, and avoid getting overlooked in a sea of hot products, or seen simply as part of an asset class that has run its course, experts said.

"The market really is the intermediary, and how you reach that segment is very, very difficult," said Burton J. Greenwald, president of B.J. Greenwald Associates, a fund consulting company in Philadelphia. Unlike brokers, who are often housed in one place, the registered investment adviser [RIA] community is far more fragmented. "It requires Internet communication, sophisticated strategies and much more rifle-shooting than reaching conventional wholesalers," Greenwald said.

And independent advisers cannot be ignored. According to data from Boston-based Cerulli Associates, at the end of 2006, the 15,000 RIAs across the country managed $1.8 trillion. Respondents to the Schwab survey alone represent $347 billion under management.

Because they are known for their slow-and-steady approach, advisers are also a good indicator of enduring trends, rather than fast-moving fads. Of the 1,400 RIAs who took the 10-minute online survey, 75% use ETFs, and half of them said that they would increase their ETF allocations in upcoming months.

"Advisers are savvy people. They look at the basics and have done a reasonable job of separating the wheat from the chaff," said Gary Gastineau, principal of Summit, N.J.-based ETF Consultants.

As markets slow down, and investors become more cost-conscious, low-cost ETFs have become particularly useful alternatives to more expensive index mutual funds, especially in taxable accounts, said Joel Kelley, a certified financial planner with Woodstone Financial in Asheville, N.C., and president of the Western North Carolina Chapter of the Financial Planning Association. Because they track indexes, and appear in portfolios much like any other security, Kelley said they are also easy to explain to clients.

"We take the premise that ETFs are pieces of mutual funds that we can be more specific with," he said. "I prepare them that it's not going to really be a big tool in their portfolio, but just another tool," said Kelley, who uses the Fidelity platform.

Gastineau credits the increased use of ETFs to an increased focus by manufacturers on sales. Barclays, for example has a sales force of 120 dedicated to its ETF line, he noted, while State Street has a similarly sized sales team. Even Vanguard, which does not use wholesalers to sell its mutual funds, has a force of 30 introducing ETFs to RIAs.

While advisers are interested in the products, they are also highly selective. "We use them where we feel they appropriately fit," said Evelyn MacIntyre, chief compliance officer of Capelli Financial Services in Bloomfield Hills, Mich., and president of the FPA chapter for the state. "We don't just chase the popular investment," she said.

That's where the industry may go wrong, Greenwald suggested. "The mistake that some are making is slicing the salami thinner and thinner and coming up with narrow wedges of the market that may be in vogue, but have no real permanent position in most people's portfolios," he said.

While ETFs continue to evolve as tools for investors, real estate funds may have had their run, according to the Schwab survey. Twenty-five percent of those advisers who invest in REITS plan to scale back or discontinue their investments. Seventeen percent of advisers with other types of real estate holdings said the same.

Clients, meanwhile, have been raising questions about real estate, as they have watched housing values depreciate, Kelley said. "They are scared in general, because they lump all real estate together," said Kelley, who sometimes uses international REITs as part of his 20% non-U.S. allocations. After talking to their advisers, most clients agree to keep REITs, he said.

Still, in order to distinguish themselves as indispensable, REIT managers must articulate their enduring attributes. Such clear messages will help advisers convincingly assuage their clients' fears, Greenwald said.

"REITs have had such a run in the past 10 years, it's been extraordinary by almost any measure," he said. Many advisers, he said, look at the double-digit growth over the past five years especially, and have decided to scale back.

"You have to make the case [for REITs] not as a fad or product of the moment, but as an asset class with, for the most part, very little correlation with equity markets," Greenwald said. "In other words, you have to take them out of the universe of hot stocks, so to speak."

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