Diversification is king; at least, so it should be.
The importance of having a properly diversified investment portfolio has been expounded by so many for so long that it ought to be a mantra that is seared onto every investor's consciousness.
The core tenet is simple: avoid concentration risk in any one asset class, sector or country by diversifying your investments across asset class, sector and geography.
Understandably, this can lead to higher portfolio fees as investors patched together do-it-yourself portfolios of bits of this and that and whatever takes their fancy after reading their latest client newsletter.
The question of how to maintain a well-diversified portfolio without retaining the high management or transaction costs involved has led, over the past few decades, towards the use of passive funds within a portfolio.
Pierre Debru, head of quantitative research and multi-asset solutions for WisdomTree Europe, said as exchange-traded funds are listed on market exchanges, they "regroup" all the characteristics of classic open-ended mutual funds, as well as other features.
He lists these as:
- High liquidity.
- Intra-day trading.
- Low fees.
He says ETFs as a wrapper are an "incredible improvement for investors" and the high growth of the European exchange-traded products market is testament to this.
This has been evident in the institutional space, such as default pension funds, where the focus is as much on keeping costs low as it is about driving investment performance. Take the National Employment Savings Trust, the government's flagship auto-enrolment scheme.
Nest does offer access to active fund managers, when there is need to expose members to a particular type of asset or market that cannot be gained through passive investing.
But in its 36-page investment approach document, called Looking after members’ money, Nest also states: "Investing passively is generally better value than paying a premium for a fund manager to actively select individual securities.
"Active management can be expensive and, on average, active managers in many asset classes tend to underperform passive benchmarks in the long term."
This approach is being replicated in the world of retail investing, too, and not just among those using a DIY approach.
Advisers and wealth managers are also keen on integrating passive funds within a multi-asset strategy, as Barry Cowen, senior fund manager, collectives and model portfolio solutions at Sanlam Wealth, explains.
He says the use of passives – whether straightforward index trackers, smart beta or ETFs – is a great "tactical tool" for constructing a model portfolio. He gives the following three reasons for Sanlam's use of passives in this way:
- Lower cost.
- Provision of core beta.
- Creating a core-satellite approach.
How multi-asset portfolios of passives are constructed along these three lines will be considered in more detail further in the article; but for Christian Tomaszewski, financial adviser at Timothy James & Partners, part of the reason why advisers and wealth managers have been using passives has been a regulatory one.