A low-cost philosophy

Gary Mairs, chairman of the investment committee at TCF Investment, talks to Charlotte Moore about how the use of ETFs supports the firm’s low-cost investment philosophy

Why have you started TCF Investment?

David Norman and I started the firm to offer the retail market a low-cost, multi-asset portfolio that invests in passive instruments. We started from the point of view that the investment performance of an actively managed multi-asset portfolio is eaten away by the costs associated with these funds. By using passive strategies, we can still offer a well designed multi-asset portfolio but save over 2% a year in costs. That doesn’t sound like that much money but when it is compounded over time, it makes a significant difference to the investor over the long-term. If you look at the performance of the upper quartile of the balanced fund IMA sector over any time period, it is significantly less than 2% per annum.

Tell us more about the investment philosophy behind TCF Investment?

We are going through the process of launching four funds, which we hope will go live in the next couple of months, subject to regulatory approval. 

We are offering four different types of fund to suit the different risk appetites of retail investors. The lowest risk fund will comprise 20% equities; the two other funds will have 40% and 60% respectively invested in equities while our highest risk fund will have 80% of its assets invested in equities. The low risk funds will have a greater exposure to European and US equities while the higher risk fund will have more invested in emerging market equities. 

The balance of the portfolio will be mainly invested in fixed income with a smaller amount invested in commodities and property. We will never invest more than 5% of the portfolio in commodities. We aim to generate the maximum level of return for the appropriate level of risk for each fund.

How will you use ETFs?

Once we have decided on the asset allocation, we want to find the lowest cost way of implementing that strategy. We have three alternatives: ETFs, index futures and institutional mutual funds. As the funds are aimed at the retail space and are structured as open-ended investment companies, only 10% of the fund can be invested in derivatives so a maximum of 10% can be put into index futures. Making the choice between these three will involve an analysis of the risk and efficiency benefits at the time we make the investment. We will also need to examine the risks involved in the products we are considering, in particular counterparty risks. But the advantage of an ETF is that it is priced on a daily basis and it is cheap and easy to use.

Are there any asset classes especially suited to ETFs?

In principle, ETFs are suitable for all the mainstream equity and fixed income markets. But before choosing any particular ETF, we would look at the technical details and make sure that we had a handle on potential risks. For other less mainstream asset classes, such as property or commodities, we need to see what the underlying investments are inside the ETF but if that checks out, then this is no reason why they cannot be used.

Are there any types of ETFs that you would not use?

The funds are focused at the retail investor so we do not feel it would be appropriate to use active ETFs, those that are designed to produce leveraged returns or ones that aim to short a particular index. These are quite sophisticated and quite risky instruments.

Do you prefer traditionally replicated or synthetic ETFs?

In principle, we have no particular bias in favour of either type of ETF but with a synthetic ETF there is greater risk and we will make sure that we research and understand these risk issues. We need to familiarise ourselves with the collateralisation processes and the mark-to-market issues, as well as any possible counterparty risk.

Do you prefer one particular ETF provider?

There are advantages and disadvantages to every ETF from each and every provider. It is only possible to discover these differences by going through the due diligence and talking to the technical people. We will have to weigh up those pros and cons and decide which cons we can live with and which pros we cannot do without. As we will be using such a large number of ETFs, we will ensure that we balance out the risks by using a range of different providers.

Is there any particular ETF that you find exciting or interesting?

The ETF that excites me the most is the one that is the most boring. I do not want excitement from ETFs. We are using ETFs to provide our investors with a low-cost, multi-asset strategy so we want ETFs that do what they say they will do and have no hidden surprises. I want to feel very comfortable about using these instruments.

Is the ever expanding range of ETFs a good or a bad thing?

In theory, the increasing range of ETFs is good as it drives down costs and increases transparency. It creates more work for us as there are more products to research. On the downside, the greater choice means the retail investor either needs to spend more time researching them or finding someone who can research for them. The more esoteric ETFs can be particularly confusing, and there is a very real risk these can be misunderstood.