PassiveSep 26 2016

Buying into less-common strategies

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Buying into less-common strategies

Passive products such as exchange-traded funds (ETFs) have traditionally focused on offering exposure to large-cap equity indices, such as the FTSE 100, and more recently to fixed income.

But a growing number of providers have launched passive funds that sit more comfortably in the alternatives investments category – a ‘catch-all’ term for any asset classes that are not traditional equities or fixed income.

Passive providers have been consistently gaining market share from active asset managers due to the appeal of these low-cost products as a way of accessing equities and fixed income, so it is no surprise they are now trying to corner the market in more niche areas. 

Howie Li, executive director of Canvas at ETF Securities, says: “Multi-asset portfolios have core allocations to equities and fixed income, and because of the challenges within those two asset classes, people are either looking for alternative sources of return or ways to diversify their portfolios.” 

Mr Li acknowledges that what “gets parked into alternatives” is a wide range of assets, with some providers including commodities in this category. 

They can be very much momentum-led and investors could get caught up in a ‘hot money’ play very easily. Darius McDermott, FundCalibre

Figures from ETFGI show by the end of July exchange-traded commodities (ETCs) and exchange-traded products (ETPs) had gathered a record level of net inflows of $10.1bn (£7.8bn). This was still some way behind the $22.4bn of year-to-date net inflows into fixed income ETFs, but ahead of equity ETFs, which recorded net outflows over the same period. 

Gold passive products account for a large proportion of these inflows, as macroeconomic uncertainties have seen investors allocate to the asset class. 

Lynn Hutchinson, assistant director at Charles Stanley, says: “Gold ETCs have been available for many years, but have attracted large investor assets this year.” 

Mr Li notes: “Gold traditionally is a safe haven and fixed income is the same, but correlation-wise they’re not always the same. It’s a good way to hedge against risk.” 

FundCalibre managing director Darius McDermott notes it is not just alternative asset classes like gold that can be accessed via passive strategies. Investors can get exposure to more niche areas of mainstream investments through ETFs, such as mortgage-backed securities, Chinese shares, megatrends like robotics, and oil. 

Ms Hutchinson adds: “A fairly new strategy of investment has been the launch of socially responsible ETFs. These rules-based ETFs track an index that is then screened based on a number of criteria. Many are screened for a company’s corporate governance, profits from tobacco, animal testing, armament and others.” 

UBS is one such provider with a range of sustainable ETFs that are built around the MSCI SRI indices. Head of ETF sales for the UK and Ireland Andrew Walsh notes this was still a very specialised area of investment a couple of years ago. 

“We’ve had assets grow from £250m across this suite of ETFs to about £650m in 15 months,” he says. “The key inflows into ETFs still go into the plain vanilla kind of things – the S&P 500, the FTSE 100 and the MSCI World [indices].” 

But Mr McDermott queries whether some types of alternative strategies are suited to retail investors. “They can be very much momentum-led and investors could get caught up in a ‘hot money’ play very easily. For example, the massive fall in the gold price [between 2013 and 2015] was exacerbated by the fact that a lot of money had piled into gold ETFs and was then pulled out very quickly,” he says. 

“When it comes to oil, if you don’t want to buy actual barrels or oil company shares, then you could buy an ETF, but you have to think about contango and backwardation – not concepts most retail investors are familiar with.” 

Ben Seager-Scott, director of investment strategy and research at Tilney Bestinvest, also doubts the suitability of using alternatives in an ETP or passive format, although he admits there will be demand for these products. 

“ETPs generally work best for large asset classes that are liquid and transparent – which is why they tend to work well for areas such as UK large-cap equities, where you can easily buy a FTSE 100 ETF, or UK gilts,” he says. 

“ETCs can also work fairly well for other physical, non-perishable and easily-stored commodities, such as other precious metals and industrial metals, but it is much less feasible to physically hold something like oil or wheat. These ETCs are more sophisticated and use derivatives, usually based on futures pricing.

“I think alternative asset classes are fairly safe from the passive industry threat, which is more focused on equity themes and styles as well as fixed income.”

Ellie Duncan is deputy features editor at Investment Adviser