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Alternatives to exchange-traded products

This article is part of
Guide to Exchange-Traded Products

Passive funds are the closest alternative to ETFs, according to Ben Thompson, director of business development, listed products and ETF UK of Lyxor.

He says the major difference is the creation/redemption process, which is a lot more complex for passive funds.

ETFs can be bought and sold immediately, just like a stock when markets are open. However, Mr Thompson says the creation/redemption of a passive fund must be ordered long before being executed, through a long process involving many parties (platform, custody, asset manager).

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Also, Mr Thompson says because ETFs can be created or redeemed as demand increases or falls, the price of the ETF always remains close to the net asset value of the fund. Mr Thompson says a passive fund by contrast may trade at a premium or discount to the net asset value.

On the other hand, Hortense Bioy, director of passive funds research at Morningstar, argues conventional tracker funds represent a good alternative to ETFs, especially for buy-and-hold investors seeking to invest for the long term.

Ms Bioy says: “There is a multitude of tracker funds that follow equity and fixed income indices in the UK and globally, although the choice is not as large when compared to the menu of exposures available via ETFs.

“Also, to gain passive exposure to commodities, and especially single commodities, investors have little option but to go down the ETP route.”

Mr Thompson says those who prefer a more active approach may prefer to use actively managed funds as an alternative to ETFs offering the potential to outperform the index.

However, Mr Thompson says not all actively managed funds do successfully outperform their benchmark index consistently.

He says: “Those that do (outperform) one year may not be the same as those that do the following year.

“Plus, the much higher management fees associated with actively managed funds can make them less attractive than a simple ETF tracking strategy.

“Instead of buying exposure to the selection of bonds, commodities or stocks created by an index through an ETF, advisers could try to create their own selection of stocks or bonds.

“However, this can concentrate risk around a few stocks or bonds, leading to higher risk in the portfolio. Potentially the trading costs would be higher too, as advisers would pay for each stock purchased rather than a single charge for the ETF.”