ETF Wrap

What Is an ETF Wrap?

An exchange-traded fund (ETF) wrap is a type of special investment portfolio in which an investor—with or without the aid of an investment advisor—invests solely in ETFs.

The composition of each ETF class is initially based on a pre-selected asset allocation model; it will periodically need to be rebalanced in response to changes in market values.

How an ETF Wrap Works

Common asset allocation models for ETF wrap fee programs are 100% equity, 100% fixed income, or a balanced model—both fixed income and equity. The choice of model depends on an investor's age, tolerance to risk, income, goals, and other personal factors. Investors can choose to manage an ETF wrap themselves in a non-discretionary account, or they may elect to have a professional advisor do so on their behalf (in a discretionary account). 

In general, through a wrap fee program, an individual investor is charged a specified fee or fees not based directly upon transactions in their account for investment advisory services (which may include portfolio management or advice concerning the selection of other investment advisors) and execution of client transactions.

Advantages and Disadvantages of an ETF Wrap

Simplicity is one of the primary benefits of a wrap fee program. Clients pay an annual or quarterly fee for wrap products that manage a portfolio of investments—rather than paying individual commissions for trades. For advisers who charge fees based on assets under management (AUM), these money management charges for wrap products often are additional—either billed to the client separately or through a higher adviser AUM fee to cover them.

ETF wraps are beneficial due to their low expense ratios when compared to mutual fund wraps. In addition, discretionary wrap programs may offer investors asset allocation and rebalancing services to keep their portfolio in line with their investment goals. An additional benefit of mutual fund wrap programs—access to fund managers typically not available to retail investors—is less applicable to ETFs, which are more widely available direct from the ETF sponsor. 

A possible disadvantage of wrap programs is that buy and hold investors—and those that trade infrequently—are exposing themselves to unnecessary fees by electing for a wrap program (versus paying commissions for each trade). Wrap programs are expected to protect clients from superfluous account activity—also called churning. But the opposite problem can occur if there's little trading in the account; the financial advisor may not be providing value for the wrap fee being charged.

Advisors employing ETF and mutual fund wrap programs have also been known to charge high fees—in addition to failing to adequately disclose the brokerage commissions they pay to trade investments within wrap programs. And in some cases, wrap fees inclusive of brokerage commissions are much higher than the commission costs borne by the advisor.