ETFs Increasingly Feature on Investment Menus

Emma Rees

13 May 2008

Wealth managers are increasingly populating client portfolios with ETFs and exchange traded commodities as they are cost-effective and provide the best of both closed and open ended funds. Other advantages include transparency and the fact that investors know that they can buy or sell them all day, every day, on exchange and close to net asset value in large quantities. Barclays Global Investors reports a marked increase in wealth management clients investing in ETFs and says many private banks are beginning to use them, particularly given prevailing market volatility. Eleanor Hope Bell at BGI recently told WealthBriefing that wealth managers are becoming more familiar with ETFs, and so is the end client. “In terms of growth, last year the split was approximately 20 per cent wealth managers and individual high net worth clients, compared to 80 per cent institutional clients. Today the split is 70/30 institutional versus retail, so there has been a 10 per cent increase year on year,” Ms Bell said. Ms Bell believes that ongoing market turbulence has prompted a flight to quality, which is increasing the focus on beta products over alpha: “There is so much uncertainty, why risk betting on average performance?” Manoj Mistry, who is head of structuring for db x-trackers, part of Deutsche Bank, said that whilst 80 per cent of his firm’s assets have been raised from institutional investors such as pension funds and asset managers, it has also witnessed increased activity from retail investors over the last few weeks – especially self directed investors. As wealth managers focus on separating alpha, the portion of return that is generated by a managers’ skill, from beta, that arising from market returns, they are increasingly making use of beta instruments like ETFs, he said. “They’re an access tool - a low cost way to gain exposure to an asset class or region,” said Mr Mistry. Barclays Wealth said beta in its portfolios now comes from three sources - ETFs, futures and total return swaps. It evaluates issues such as transaction costs, fees and tracking error to decide on the most efficient beta source and confirms that ETFs play an important role. Neil Michael, head of quantitative research at London and Capital, an investment firm, estimated that approaching 75 per cent of its clients’ portfolios are now populated by ETFs. Daniel Draper from ETF provider Lyxor said it was widely accepted that 90 per cent of investment performance over the long term was due to asset allocation and that ETFs provide an accessible way to populate asset allocation in client portfolios. Providers pointed to active managers’ frequent failures to outperform their peers as one reason for ETF's growing popularity. “Our clients tell us they struggle to find active managers who consistently outperform their benchmarks,” said Tim Mitchell from Invesco PowerShares. “ETFs are increasingly being accessed by wealth management houses for their clients’ portfolios as they provide exposure to markets in a cheap and effective manner,” Mr Mitchell said. “The effort and resources required in selecting the right active managers using a bottom up approach is often not rewarded in terms of payback,” agreed James Oates from SPA ETF. He believes that wealth managers' more frequent adoption of a top down approach in conjunction with education has been instrumental in increasing demand for ETFs amongst this group. The UK head of research at Lipper, the fund tracking and research firm, Dr Richard Ramyar, says that considering the deteriorating, medium-term prospects for developed world investments, it is not surprising that investors are looking at the increased choice that ETFs offer them, whether through access to commodities or sectors that buck that trend in the general market. When it comes to bucking trends, an example is the Db x-trackers short Markit iTraxx ETFs, which allows clients to buy credit protection in an ETF format, via an exchange for the first time. However, Duncan Gwyther from Citi Quilter said that although it is possible to short ETFs, his firm primarily uses them on the long side. “We use them where we find it difficult to gain exposure otherwise. One example is in Japan, where different styles of manager tend to do well only for a short space of time. It is difficult to fully research the economy, corporate profitability and stock markets quickly enough for what is a relatively small area of interest. Whilst Japan is extremely cheap by most measures, most people still don’t like it. In this situation, we use an ETF to gain the geographical exposure so we are not avoiding it completely in case it does perform. When we identify a sustainable trend, we will sell the ETF and buy the active fund,” he said. Citi Quilter also uses ETFs for liquidity reasons, for example when a client has held a certain stock it still likes but which has capital gains attached to it. “We can use an ETF to sell the market balance exposure in a portfolio,” said Mr Gwyther. It also uses ETFs when it is difficult to find an active fund to gain specific exposure such as in the case of mid-cap funds, where an ETF can provide the appropriate diversification. Thomas Becket from Psigma, the UK investment firm, has recently used a gold bullion ETF blended with BlackRock’s Gold and General Fund to express the firm’s positive view on gold in clients’ portfolios. Although he prefers gold bullion as high gold prices have, historically, tended not to be reflected in the share price of gold companies, the ETF enables him to diversify out this view. Experts believe that one of the reasons that ETFs have taken some time to take off is the lack of trail commission they provide which has provided little incentive for advisors to promote them. However, as private banking moves towards to a fee based model and the focus shifts to asset allocation rather than stock selection, ETFs are starting to come into their own.