Advisers, Gens X-Y Find Common Ground with ETFs

• MURRAY COLEMAN for the Wall St Journal writes: 
While most older investors stick to traditional mutual funds, exchange-traded funds are appealing to the generation that has grown up with them.

That could be key for advisers seeking younger clients.

At stake is an estimated $1 trillion a year in wealth expected to be transferred by older investors to younger generations over the next four decades. Those up-and-comers, often referred to as Generations X and Y, range in age from 18 to their upper-40s.

By some counts, the Gens X and Y population has already surpassed that of baby boomers who are near or already in retirement. Despite such a shift in demographics, those younger investors make up just 3% of the advisory industry's client base, say analysts at Cogent Research.

Other recent research supports such views. In a survey of more than 1,000 independent advisers, Charles SchwabCorp. SCHW +1.02% (SCHW) found that 65% of those surveyed predicted that Gens X and Y, along with women, would become a driving force in profitability five years from now. But only 14% listed those types of investors as an immediate priority.

"Generation X and Y investors haven't grabbed much attention from advisers yet," says Linda York, a Cogent vice president. "They're generally less-advanced in their careers and less-affluent in terms of their savings."

But a common ground might be forming as more advisers turn to ETFs.

Almost half of affluent investors under the age of 30 own ETFs, according to Cogent. That compares to less than 10% usage by older first- and second-wave baby boomers with $100,000 or more in investable assets.

At the same time, more than 70% of U.S. advisers say they now use such funds, Ms. York points out. "ETFs are letting advisers refine their approaches to investment management," she says.

That's a key when dealing with younger mass-affluent clients, says Matt Reiner, chief investment officer at Atlanta-based Capital Investment Advisors in Atlanta, with $1.1 billion in assets. "With more affluent investors, we can use institutional-level mutual funds that require higher minimum investments," he says. "With a bigger pool of assets, we can also buy enough individual securities to build well-diversified portfolios."

In 2011, his firm helped to launch a separate advisory service, Wela Strategies. Its portfolios are almost entirely made up of ETFs, providing an opportunity for many of Capital Investment's more sophisticated strategies to be made available to investors with as little as $10,000 in assets, Mr. Reiner says.

The startup has attracted about $60 million in assets so far. "ETFs give us the ability to adapt a management process that's based on institutional-level research to manage portfolios for younger and mass-affluent investors," Mr. Reiner says.

Big brokerages such as Bank of America's BAC +2.00% (BAC) Merrill Lynch are also trying to make inroads with mass-affluent investors, largely through online and phone-based services to manage portfolios. A host of software firms have sprouted up touting Internet-based advice as well.

"Increasingly, we're seeing advisers putting together portfolios of ETFs as an appealing and cost-effective way to service younger investors," says Aite Group analyst Sophie Schmitt.

In some cases, technology and demographics are coming together to make more advisers sit up and take notice of mass-affluent investors, says C.J. Rendic, founder of Parallel Advisors in San Francisco with about $500 million in assets.

About half of the firm's client base is comprised of Gens X and Y investors, he estimates. Part of that is due to the adviser's proximity to technology mavens such asGoogle Inc. GOOG +0.30% (GOOG) and Salesforce.com Inc. CRM +2.19% (CRM). But another factor that Mr. Rendic points to is that most of the firm's advisers and managers are in their 30s or 40s.

His staff is adept at communicating through social media, he adds, and relates to wealth-management issues facing Gens X and Y as they grow older. The combination has led the firm to promote an investment philosophy built around low costs, tax efficiency and transparency, Mr. Rendic says.

"The lower fee structures and index-bias presented by ETFs seem to resonate with Gen X and Gen Y investors. They've become a key part of our growth," he says.