The vanilla appeal of ETFs

Lee Robertson at Investment Quorum talks to Joanne Young about how investors are increasingly requesting ETFs and the attraction of simple products for retail

How does Investment Quorum use ETFs?
For clients who choose to have us manage their investments as well as their financial planning, we run a range of model portfolios. These include one ethical portfolio, three income, three growth and one smaller model for retail clients. ETFs are available for use within all of these portfolios.

However, we lean towards the actively managed side. The bulk of our portfolios will typically be made up of Oeics or investment trusts, with ETFs in satellite positions around our active managers. Very often we are using ETFs to gain a tactical advantage. If we like copper, for example, we would use an ETC to gain access. If we had an interest in a particular market but were not entirely enamoured with the funds that were available, or were just looking to grab a bit of the index upside, then we would use ETFs.

At the moment we look after around £130m in client assets and probably around 15-20% of that is held in ETFs at any one time.

What sort of ETPs do you use?
We definitely like to use ETCs to gain access to commodities. Within equities, we generally use ETFs for emerging market exposure.

In terms of providers, we stick with the mainstream. Clients are more comfortable with using the big names and we also find these firms are extremely good at supporting us with our due diligence. Typically, we choose from the platforms offered by iShares and Lyxor.

How do you pick between funds?
That may well come down simply to cost, or tracking error. It can also be that we want to go with a physical fund – we are comfortable with both physical and synthetic replication but we lean towards physical.

As long as we understand what an ETF is doing and why it is doing that, there are none we would not even consider. Part of the process we go through is determining a fund’s taxation status, its replication method and whether the provider does securities lending.

What are the benefits and downsides of using ETFs?
They provide immediate market access, are easily tradable and are liquid tools. Their transparency is very useful when we are promoting them to clients and a big advantage for us is they drive down a portfolio’s total expense ratio.

On the other hand, anything that is linked to an index inherits all the issues involved with composition. Often, a stock that is being promoted into in an index and so into an ETF has already used up a lot of its growth potential in order to get to that point.

Are there any developments you would like to see within the industry?
In my opinion there are already too many ETFs out there, so I would not say it is a case of needing more funds. Rather, what we do have should be slightly better and more transparent. If you take the time to understand what they are doing, the big providers are very transparent, but I suspect that as the size of the provider reduces, that may not always be the case.

We might think about using ETFs tracking enhanced indices. With all these things, you are constantly adapting and learning as the industry moves forward. For the moment though, our approach is very much plain vanilla, and there is plenty to be getting on with.