Industry experts reveal their real views on exchange-traded funds - and they're not without reservations.

The role of exchange-traded funds was under the spotlight at last week's WealthMatters event. In a panel discussion, five eminent speakers set out why ETFs deserve, or in one case do not deserve, a place in every client’s portfolio. There was a clear message to advisors, however, not to take these products at face value but to make sure you understand what you are buying and that it does what your client needs.

Opening the session, Linda-Jane Coffin, product director at S&P Capital IQ, said that ETFs are popular as they appear simple, transparent, efficient and low cost, though she feels that “lower cost” would be a more accurate description. With 1,370 ETF products available across Europe investors are spoilt for choice. Therefore it is essential to ask the right questions and be aware of hidden costs. However, she said that S&P believes that there is a place for ETFs in every portfolio and would like to think that they could be bought and that “people could sleep easy at night”.

Coffin’s call for caution was reiterated by Jerome Lussan, chief executive officer of Laven Partners. He stressed that when buying ETFs it was essential to “trust but verify”, notably when dealing with synthetic ETFs. Nonetheless, Lussan said that ETFs can have a number of advantages over mutual funds, including their liquidity, usefulness in diversification and specifically that they make it easier to invest in complicated assets such as futures. He also noted that in Europe ETFs were usually UCITS and complied with listing rules making them more reliable investments. Underlining the importance of detailed and processed due diligence, he warned that “a product that you cannot understand is not worth buying, no matter what the returns are”.

Weigh up the options

Beverley Sharp, global head of retail research at Mercer, continued on the theme of caution, saying that it is important to work out exactly what the client’s objectives are before deciding whether ETFs are the right investment vehicle. She said that Mercer advocates using passive products to help achieve key client objectives and outlined a number of circumstances when they might be recommended. For example, she observed that ETFs can be of particular use “if you want to change allocation to an asset class, but don’t want to sell down a manager as it is a short-term view”.  She added that these objectives can be achieved by using other vehicles so ETFs should be weighed up against all the options.

Mark Johnson, managing director of iShares focused on the importance of understanding the client’s point of view. “Many clients see themselves as savers not investors, they want outcomes,” he commented, adding that wealth managers need to “help clients adopt a relevant flight plan for their journey”.  Johnson sees ETFs having a key role in this process saying “ETFs are a smart tool, they help you to be precise, to fine tune around a core, to hedge and attain liquidity”.

A word of caution

The one dissenting voice on the panel was Peter Sleep, senior portfolio manager at Seven Investment Management. His view is that in most situations there are better alternatives available than ETFs. He said that it is often cheaper to buy the underlying investment and described futures as “virtually free”.  Sleep did, however say that he does occasionally use ETFs, but only where can’t find a suitable tracker fund or alternatives in a particular asset class.

Responding to Sleep, Johnson restated that it was important to establish what a client wanted. “If they want quick exposure to a market then it’s an ETF: if they have more thinking time then other products would be considered.”

The panel provided a number of useful tips on how to assess an ETF and what questions to ask. Sharp’s advice was to do your own research on any product saying: “Don’t take at face value what you are told by the asset manager.” Lussan recommended studying the prospectus carefully to establish who is behind the product, noting that it may not be the company that is marketing it and it could be an unknown name. Coffin said that it was important to look at the people and processes involved, to establish the investment team’s experience in ETFs and to question how performance is achieved. Johnson agreed that “due diligence is key” saying that, in the case of synthetic ETFs it is important to identify who the counterparties are and what steps are being taken to make sure that clients get their money back “if things go wrong”.

The conclusion? ETFs can play a very useful role in most clients’ portfolios, but “buyer beware”.