InvestmentsOct 24 2014

Trackers outpacing ETFs in adviser passive push

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Growing adoption of passive investment strategies by advisers is benefitting traditional open-ended trackers more than exchange-traded funds, as vagaries associated with synthetic replication methods and inferior compensation scheme protection weigh on recommendations.

Passive ETFs are similar to index trackers in that they are designed to replicate the performance of a benchmark but they trade like shares on an exchange, meaning they can be bought and sold intra-daily and experience more dynamic pricing changes.

They give the ability to sell short, buy on margin and to buy in more bespoke quantities starting a single share, while also generally charging a lower expense ratio, although additional commission is typically paid to a broker.

Launches of new ETFs have been coming thick and fast, especially from the big US passive fund houses like BlackRock and Vanguard. At the start of October the latter launched four Irish-domiciled ETFs, bringing its total offering listed in the UK to 13 funds.

Tim Huver, London-based ETF product specialist at Vanguard, told FTAdviser that the same trends are beginning to happen in the UK as they did in the US and that there had been “a natural evolution from institutional ETF use to retail”.

He added: “This is particularly evident in ETF inclusion on platforms and advisers using them through discretionary management and building model portfolios.”

However, while Deborah Fuhr, managing partner of specialist consultancy ETFGI, similarly pointed out ETF use is growing, she cited in particular the launch and growth in accounts and assets on DIY trading platforms.

This accords with the views of the likes of Patrick Connolly, certified financial planner at Chase de Vere Independent Financial Advisers, who told FTAdviser that the firm does not currently use ETFs and prefers trackers in client portfolios.

“ETFs do allow investors to get exposure to a wide range of asset classes, in real time and with low charges, which is particularly appealing when you consider that many actively managed funds under-perform.

“However, they can be complex, particularly ‘synthetic’ ETFs which can be difficult to understand and expose investors to an additional level of counterparty risk.

“It is also important to recognise that they don’t benefit from the protection of the Financial Services Compensation Scheme.”

As ETFs are classified as shares, they are not covered by the FSCS in the same way as the scheme only offers protection relating to financial advice and investment firms.

Mr Connolly added that charges may not be as cheap as they initially seem for smaller investors or those who are rebalancing in their portfolio, because stockbroker’s costs need to be paid when buying or selling.

Tracker sales have been on the up of late: IMA statistics showed funds held in open-ended passive funds rose above £80bn for the first time in June and had risen sharply to £85.2bn by August, meaning for three consecutive months the proportion of total assets have been above 10 per cent.

Malcolm Coury, founder of Bath-based Money Wise IFA, suggested ETFs in the intermediary market would predominantly the preserve of wealth managers, rather than “run of the mill general practitioner IFA firms”.

Ben Thompson, director of business development for listed products and Lyxor ETFs at Societe Generale, told FTAdviser that there have been questions from the adviser community about how ETFs work, so the firm has been rolling out a series of educational materials.

He said: “I can completely understand that synthetic ETFs felt like a black boxes, people didn’t like not knowing, so we’re aiming for complete transparency of what’s in a portfolio and we try to hold 100 per cent of physical assets.”