Attractive option for portfolios

This article is part of
Appetite for diversification

Attractive option for portfolios

The popularity of exchange-traded funds has exploded in recent years.

In 1998, there were only 29. By the end of 2018, there were more than 1,900 ETFs investing in a wide of range of stocks, bonds, and other securities and instruments, according to data from the Investment Company Institute.

And since the Retail Distribution Review there has been a gradual reduction in the overall costs of multi-asset portfolios as advisers demand that fund managers be more transparent and reduce their costs, driving up the use of these products even more.

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Justin Onuekwusi, a multi-asset fund manager at Legal & General Investment Management, says: “More and more ETFs are becoming in vogue, more mainstream, and importantly they are starting to compete on cost with the big index players or the big index mutual funds.

“The other things ETFs give you is real-time performance. You can effectively align your ETF with the pricing point of the overall funds, which makes them very attractive.”

ETFs, which are a type of index fund, offer shares in a pool of investments designed to pursue a specific investment goal. 

Key points

  • ETFs in multi-asset funds can keep costs down
  • Passive investing is not necessarily the best during falling markets
  • A combination of passive and active is the better option

ETFs cover a broad range of asset classes and can give exposure to specific markets, sectors or investment strategies.

The types of ETFs in the market have also evolved in recent years, and now cover everything from mainstream asset classes to niche investments or particular portions of a given market.

Fund manager Fidelity notes that ETFs can provide exposure to a variety of asset classes such as equities or fixed income by:

• Following the performance of a market index, such as the FTSE 100 or the S&P 500;

• Following the performance of a smart beta index, such as the S&P 500 Minimum Volatility or MSCI Europe Value;

• Being actively managed by an experienced and dedicated manager.

Smart beta refers to a methodology of index construction that seeks to achieve better risk-adjusted returns compared with traditional market capitalisation-weighted benchmark indices. 

Actively managed ETFs

Lately, the market has also seen the emergence of active ETFs. 

Actively managed ETFs invest in a portfolio of securities that is chosen by a fund manager on their own, rather than being based on a rules-based index. The idea is to perform better than a benchmark through flexible active management.

As ETFs have continued to grow in popularity, they have become a key part of multi-asset portfolios, not least because they help keep costs down.

In the case of the largest, most liquid equity markets, such as those in the US or UK, ETFs tracking these indices can cost as little as 0.05 per cent.

However, an investor should always understand what is in the underlying index. Additionally, as cost is important, so too is risk and return. 

Core and satellite approach

Caroline Baron, head of ETF EMEA sales at Franklin Templeton, explains that the products can be useful in a multi-asset portfolio as part of a core-satellite strategy.