ETF Wraps

One of the newer investment products that many people are quickly becoming familiar with is ETF wraps. While electronically traded funds have been popular for quite a while now, packaging several ETFs into one managed account provides more than the sum total of each individual indexed fund would on its own. There are in fact different types of ETF wraps which can be invested in so it is important to understand the difference between them before making that initial investment.

Getting Familiar with ETF Wraps
Even though ETFs are securities that track indexes they are traded on the open market like a stock. Each ETF tracks a very specific commodity or basket of assets so that the investor would need several different ETFs if more than one type of security would be invested in. The concept of an ETF wrap makes it possible to have a fund where several commodities would be included so that several indexes can be invested in within that one wrap fund. These funds are also called ‘managed accounts’ since there is a fund manager who chooses ETFs for the fund based on the model (strategy) the wrap is based on and there are two main types which are discretionary and non-discretionary ETF wraps.

Discretionary vs. Non-Discretionary ETF Wraps
A discretionary ETF wrap is set up much like a mutual fund wrap with the main difference being that one is comprised of electronically traded funds and the other is comprised of mutual funds. In a discretionary wrap the ETFs are included based on an asset allocation model. For example, one wrap may allocate 75% of the wrap may be allocated to one type of ETF while the other 25% will be allocated to another type and within those there may be sub-classifications as well. The point being that type of ETFs within the wrap are pre-selected based on allocation models. In a non-discretionary ETF wrap there are no pre-defined percentages and the account manager prescreens ETFs for inclusion, makes a recommendation and the investor becomes responsible for approving or vetoing those ETFs in order to rebalance the portfolio.

Managed Accounts
Another of the main differences between an ETF wrap and individual ETFs is the cost to the investor. Although ETF wraps generally require larger initial investments, most often with a pre-established minimum amount, the actual cost associated with fees is less with a wrap. This is because the investor pays a commission (brokerage fee) on every transaction when buying individual ETFs. On the other hand, since ETFs are constantly being traded (based on the model – discretionary vs. non-discretionary) an ETF wrap simply requires an account management fee. Most often these fees are standard and not based on a commission as would be the case with individual transactions. This only makes sense because there are ETFs constantly being traded day to day according to the model. If a commission were paid on each one it would run into a great deal of money!

Just as mutual fund wraps have quickly become quite fashionable so too are ETF wraps gaining in popularity. Part of the reason is because the individual investor can leave much responsibility in screening funds to the wrap account manager but also because of the diversity they offer at much less the cost. Each ETF managed account will require a minimum initial investment, often in the tens of thousands of dollars, but the fee associated with the fund is significantly lower. Before investing in ETF wraps take the time to see what the model is that the wrap is based on and whether or not it closely resembles the strategy that you use when trading ETFs.

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