Exchange-traded funds make effective vehicles for executing dynamic asset allocation strategies by providing exposures to the broadest possible indices.

“Current cutting-edge asset management concepts revolve around dynamic asset allocation, and ETFs are the best way to accomplish that,” said Paul Ingersoll, managing partner and portfolio manager at Good Harbor Financial, which has $6.5 billion under management.

The underlying premise of Good Harbor’s U.S. tactical core strategy is that equity prices are driven by changes in investor equity risk premiums, and that these premiums vary over time.

The concept of active investing on the basis of changing risk premiums is broadly-based. “portfolio asset are invested in ETFs that track the returns of such indexes as the S&P 500, Russell 2000, and Barclays Capital U.S. Treasury Bonds. “ETFs have given us the flexibility to access these indices very efficiently,” Ingersoll said.

ETFs themselves are being designed to replicate dynamic asset allocation.

Invesco PowerShares RAFI Fundamentals Weighted Portfolios are based on the Research Affiliates Fundamental Index methodology. This Index methodology uses four fundamental measures of company size: book value, cash flow, sales and dividends, to select and weight index constituents.

By using four fundamental factors rather than one, the RAFI Fundamental Index methodology is thought to be a more robust means of capturing a company’s true economic footprint.

Invesco has announced that the PowerShares Fundamental suite of ETFs recently passed the $5 billion assets under management (AUM) mark.

“Invesco PowerShares pioneered Fundamentals Weighted ETFs introducing the first broad-based U.S. 1000 portfolio back in 2005, followed by international portfolios in 2007, and the first fixed-income portfolio in 2010,” said Andrew Schlossberg, head of global ETFs at Invesco PowerShares. “Investors are readily adopting Fundamental strategies along with low volatility, high beta, and momentum-based ETFs as potential effective smart beta portfolio solutions.”

“We believe the PowerShares Fundamental ETFs provide investors an important alternative to passive cap-weighted strategies, and also represent great value compared to actively managed portfolios when relative performance and fees are considered,” noted John Feyerer, head of product strategy & research at Invesco PowerShares.

Within the asset management community at large, ETFs are viewed as a vehicle to gain exposure to a broad range of indices efficiently.

“We don’t think of ourselves as ETF specialists per se,” said Ingersoll. “Most of us have dealt with separately managed accounts, and the best way to get exposure within a separately managed account is via an ETF.”

By allowing portfolio managers to make adjustments based on perceived changes in market mechanics, ETFs are well suited to a dynamic asset allocation strategy, which has come to replace passive allocation as the strategy of choice among forward-looking managers.

“The style box concept of investment, which came into vogue during the 1990s, is based on the notion that individual managers can’t beat benchmarks, so you should just invest in passive index funds,” said Ingersoll. “In reality, there is no such thing as passive investing. Vanguard offers more than 400 low-cost passive index products, so you need some help in choosing among those 400 products.”

A style box is designed to visually represent the investment characteristics of fixed-income (bond), domestic equity (stock) and international equity (stock) securities and their respective mutual funds. A style box is used to determine the asset allocation and risk-return structures of their portfolios and/or how a security fits into their investing criteria.

“The problem with style box investing is its dependence on the market going up,” Ingersoll said. “The way of reducing that dependence is to have a dynamic asset allocation, which accounts for the fact that when correlations are high, there will be periods when all assets will go down in value.”