The use of exchange traded funds in portfolio management has been revving up since the financial crisis when investors wanted flexibility in investing—the ability to get their money in and out quickly.
It prompted investors globally to put a record $51.3 billion (€39 billion) into exchange traded products (which included ETFs and commodity-based products in December 2008), a figure that was only challenged in September last year.
Since 2008, assets under management in ETPs globally have risen 102 per cent from $1,483 billion (€1,116 billion) to $2,993 billion (€2,252 billion) as of mid-February, according to data from Deutsche Bank.
And demand for the products is set to continue rising.
A survey in January by State Street Global Advisers (SSgA) of 260 European corporate pension plans and 41 UK active fund managers showed that 47 percent of European corporate pension plans planned to increase their allocations to ETFs over the next five years, while 42 percent of the UK active fund managers would raise their use of ETFs in the future.
Of this, 46 percent of pension professionals thought that cost effectiveness was key, followed by 44 percent who chose liquidity. About 34 percent said ETFs provide better market access. The results were presented at the 20th anniversary of the launch of the SPDR S&P 500, the world’s largest ETF.
While the charge is now on to invest in ETFs, some investment portfolio managers have been quietly—and confidently—using them well before the boom and are already looking at other options.
One such firm is Seven Investment Management (7IM) which has been using ETFs since inception in 2001. The firm is headed by Justin Urquhart Stewart, who says that they originally started using passive index trackers (ETFs) because they wanted trading flexibility.
“However, we soon realised that when you looked at the range of passives you can build a whole portfolio with them. The passive vehicle has now become a key tool in the industry.”
Stewart and fellow founding partner, Chief Executive Officer Tom Sheridan, set up 7IM because they could not find an investment management company they would trust with their own pension money.
Today 7IM has over £4.5 billion (€5.2 billion) under management.
The firm has a range of funds you can invest in. They are designed and labelled clearly for a range of investors—from the risk averse to the adventurous. For each type of investment, there is a dedicated team designed to work on the asset allocation of that particular portfolio.
Each portfolio, or fund, uses a range of products including index trackers, futures, ETFs and even buying the underlying.
This wide range of product exposure has now prompted them to question whether ETFs are the best product for the moment.
Peter Sleep, senior portfolio manager at 7IM, said: “Right now ETFs are more expensive than anything else and therefore they are not the first choice.”
He argues that index trackers are ideal for investors who want to hold with the same exposure, but at a cheaper cost. “You only lose the ability to trade intra-day, but if you are going to buy and hold you wouldn’t be doing this anyway,” says Sleep.
Sleep adds: “We started ‘blending’ (passive and active) products eight years ago and we started diversifying away from ETFs when Vanguard came to London four years ago. This is when we looked at the tracker industry, but the problem for the tracker industry is that they have no marketing budget so not enough people know they are out there.”
“There is a lot of bravado from people saying they like being able to trade intraday, but the reality is the opposite. Long term investors put stuff away for five to seven years.”
According to Sleep, until recently the FTSE AllShare tracker was 10 bps and the cheapest ETF was the iShares Ftse Allshare at 40 bps. You may not pay stamp duty on the ETF as you do on tracker, but while the first year cost on the tracker is 60bps and then 10bps thereafter, the ETF is 40bps every year.
“ETFs are good for short term trading,” Sleep says. “But, for anything longer than 18 months, a tracker is better.”
Part of the firm’s core principles—that the investment process is the same whether you have £5,000 (€5,731) or £5 million (€5.7 million)—has led them to look for the best way to access markets. It has prompted them to use smart beta.
Sleep says: “We like it and we use it. There are inefficiencies in the indexes and this offers an opportunity for investors to get away from a cap-weighted indices. It is then up to the investor to choose what type of smart beta they want.”
Despite this, both Stewart and Sleep are keen to impress that they always return to the core principles of the business.
Stewart says: “We are trying to get away from the idea that if you are poor, you don’t get the best service. There will, of course, be variations and differences from client to client though,” says Stewart. “The whole aim of the business has been to provide investment portfolios which are straight forward that people can see and understand.”
In order to provide the best service, the firm collaborates with Chicago-based investment advisor firm Ibbotson for all its long-term-view (portfolio) work, they attend regular board meetings. The teams constantly review their strategic asset allocation portfolio and run a quarterly tactical asset allocation meeting with a board of independent advisers who have particular expertise in a certain area—this also includes Ibbotson.
They are more hands on with short-term asset allocation and have a day-to-day portfolio management team—and this is where they feel they add value.
“We are able to make changes as we go along so there is no heavy re-weighting or violent movements. It helps in reducing the risk and lowering costs,” Sleep says.
However, Stewart credits 7IM’s success with following three simple rules: “Rule one, don’t lose the stock. Rule two, refer to rule one. Rule three, try and grow it over time.
“Our task is to be as steady and sturdy as possible. It means that if you are a lower growth world, we have to look at every item and try to work out where we can lower costs,” says Stewart.
He adds: “When we want to be more aggressive, it is done in terms of asset allocation rather than taking bigger bets overall. We can be accused of being a bit dull, slow and steady. You can add sex and violence later if that is what you want.”