Many investors like the simplicity, transparency and low-cost nature of passive funds.
It goes without saying that putting together a portfolio of passives has become more popular over recent years, but as the events of 2008 and Covid-19 have shown, simply placing trust in traditional market-cap weighted indices has not always worked in investors' favour.
In fact, many have experienced more volatility than they may have expected, leading many investors and advisers seeking alternative routes to portfolio construction.
This is where smart beta and exchange-traded products come in, with investors appreciating the passive features but the greater investment flexibility and choice that allows for a less constrained investment approach.
Tim Morris, IFA with Russell & Co, talks to FTAdviser In Focus about why investors are looking into ETPs.
FTAdviser: Why are smart-beta passives and ETPs becoming more popular vehicles for more esoteric investment strategies?
Tim Morris: Increasing use of passives has massively helped drive down the costs of investing in recent years. As commendable as this has been, as with anything in life, there is never one winning formula.
And even if there were, it wouldn’t come without its issues. For example, tactical asset allocation can only get you so far should bonds once again become correlated to equities.
The ability for ETFs to target a more nuanced and esoteric strategy means more choice for investors.Those who invested in the 20 years or so before 2000 would be familiar with positive correlation between bonds and equities. And, ever since quantitative easing started in 2009, many investment bankers have been wary of overly inflated bond prices.
The increasingly sophisticated nature and increased flexibility of ETFs explains their rise in popularity.
Their ability to replicate direct holdings in an asset class and for leveraging means they have much broader appeal, especially when it comes to sustainable, or impact investing.
Unlike a passive fund that is constrained by its index, you can be more selective about how you invest.
FTA: What are the benefits to investors in using ETF/Passive funds to access environmental, social and governance strategies?
TM: When it comes to ESG strategies, this itself is a broad church. And a contentious one.
For example, passive SRI strategies have existed for several years. However, the ability for ETFs to target a more nuanced and esoteric strategy means more choice for investors, especially those who have more specific preferences.
For me, this is where ESG crosses over to ethical investing. The ability to exclude as well as engage has increased the appeal.
After all, it’s unlikely a new emerging company is to win in the battle against the established behemoths when it comes to winning the clean energy race to net zero, especially when the incumbents can throw hundreds of millions against this.
We need only look at the number of green energy firms going bust when the environment they operate becomes more hostile.
FTA: Can anything be packaged up into an ETF/passive?
TM: As mentioned before, ETFs can invest in almost any asset class. This includes the ability to replicate assets such as currencies, or alternatives such as gold without needing to hold the physical asset.
This includes cryptocurrency and is why we are seeing them as an increasingly popular way of investing in this asset class. I use the terms ‘investing’ and ‘asset class’ loosely.
After all, most crypto investors are under age 35 and may not have little investment experience. I read a recent study saying around three-quarters of them have not previously invested in traditional assets and more than ½ don’t have a pension.
Saying that, with a market cap of around £600bn, Bitcoin can no longer be ignored as an outlier. The ability to access cryptocurrencies through a more traditional wrapper, where there is less risk of fraud and risk to the financial system, can only be positive.
As well as making them a mainstream asset class, it will likely introduce the younger crypto investors to more mainstream investments.
The fact an ETF can use leveraging means fund managers can reduce the volatility of cryptocurrency through derivatives. And hopefully will mean we see less examples of people chasing the next crypto that will “go to the moon”.
