Attractive option for portfolios

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Appetite for diversification

On this point, Morningstar explains: “Your multi-asset fund, ETFs or mix of more general funds will provide the core of your portfolio – the bit that should deliver steady returns and is unlikely to change much over time. 

“But around this you can incorporate smaller investments in more specific funds that you might have a strong belief in. This is known as a ‘core and satellite’ approach.”

Ms Baron says: “There are a lot of different applications. We see a lot of multi-managers using futures, and they are actually using ETFs as a replacement as they can be more cost-efficient.”

Passive investing has had a few good years, but Ryan Hughes, head of active portfolios at AJ Bell, notes it is important to remember that markets can go down as well as up, even if it feels so long since that happened.

Mr Hughes says: “Acknowledging that passive investing doesn’t have an ability to protect capital when stock markets are falling is vital, and this is where some of the best active managers over the years have earned their reputations. 

“Additionally, it’s important to recognise that the indices that passive investments follow can change. 

“For example, an investor in an emerging markets tracker five years ago had about 15 per cent exposure to technology companies, whereas today it is more like 30 per cent in technology companies. This can change the risk profile of the passive investment significantly over time.”

To mitigate the risks, Mr Hughes says advisers should never invest in something they do not understand.

He adds: “Just because it is passive doesn’t mean it is any less risky, and therefore it is just as important to stay on top of your investments and do your research so you understand what you have bought. Diversifying your portfolio is a strong method of reducing risk.”

Ms Baron also cautions against all ETFs being seen as the same. “You need to look under the hood to understand the structure and the cost,” she says. 

Howie Li, head of ETFs at LGIM, says there is still a huge amount of education to do on the ETF market, adding that they should be viewed in the same way as mutual funds.

He says: “Are you comfortable with the [practice of] securities lending? Do you need to have a lot of liquidity?

“Looking at the liquidity in the ETF, there are a lot of different layers you need to consider, because one ETF will not suit everyone. A lot of people assume that all ETF risks are the same. The risk here is that we are tracking the market and buying just the largest companies.