Alan Miller on the Active v Passive debate

Former New Star CIO Alan Miller, now partner and fund manager at Spencer-Churchill Miller Private, talks about active asset allocation using passive vehicles.

Q. How does your use of ETFs differ to that of other fund managers?
A. We are quite unique by investing solely in ETFs, with the whole portfolio based on asset allocation and not stock selection. We will be active in terms of changing assets, but we will do this with the lowest cost and most liquidity we can find, which is through ETFs.

We have two portfolios. One is called the longterm return, which is like a pension plan, and the other is like a hedge fund called the absolute return portfolio. We offer these in sterling, US dollars and euros, so the asset allocation changes according to which currency the investor selects.

Q. Are there any particular sectors or regions you opt to gain exposure to via ETFs?
A. We try and keep everything simple. Since we started, we have never bought a single leveraged ETF or a single inverse ETF, and we have not bought a single sector ETF.

In the future we might buy a global sector ETF for a small percent of the assets, but we believe the key to everything is to keep things simple. If you want to have 30% in the UK stock market, we will have the vast majority of assets tracking the widest index, which is the FTSE All-Share.

If we want to have a small tilt towards the large cap companies, we might have some of the assets in the FTSE 100 index. If we want a small tilt towards mid-cap, we could buy some shares in a FTSE 250 ETF. You can make some fantastic returns by sticking to the core, large liquid markets and ETFs ­and you do not have to delve down to the subterranean levels.

Q. Do you have much exposure to the emerging markets?
A. We have a small amount in the two portfolios. We have some exposure to China, India, and the frontier markets in one portfolio. To put it in context, emerging markets are much higher risk and represent under 2% of the portfolio. By the time you boil it down to the individual countries within the ETF, you have got around 0.2% of the portfolio in one country.

Q. You used to be an active fund manager?
A. We still are active, we are just low cost and liquid in asset allocation rather than active by buying and selling individual stocks. So we are active, but we are using passive instruments. Effectively our model cuts out huge waves of cost ­as it removes a huge amount of the extra distribution and fund expenses.

Q. Is there still an active versus passive debate or is this a little misleading because you can have both?
A. Yes, because we have both. We have been pretty active ­ in the last five to six months, the annualised turnover in the absolute return portfolio was about 40% to 45%. As the spreads are so tiny in ETFs, our commission rates are a fraction of an institutional commission rate, because we do not have to pay for lots of research and therefore we can change the asset allocation more quickly and cheaply. The cost of our asset allocation change might be 0.2% per annum and the cost for the average person managing it the old fashioned way is probably more like 1% per annum.

Q. Do you think total expense ratios should be renamed total cost of investment?
A. Our argument is that people should have the right to know how much the investment is costing them. The argument of some industry players is that people are only interested in their return, but obviously you do not see the return until the end, by which point it is a bit too late to work out what you are paying.

So we think people should have the right to know how much it is costing them all in. Then they can make an educated decision and can compare one fund manager with another, or can invest themselves. If an investor wants to pay high fees because a manager has fantastic performance that is fine. The worst situation is to pay someone very high fees for very low performance.

Fee levels within ETFs are coming down, which has also dragged down some of the fees for indexed retail funds as a result.

Q. Do you prefer using any particular types of ETF in terms of issuer or structure?
A. We look at all of them and have a balance of providers and structures. We take into account every factor from the size of the ETF, the size of the spreads, the tracking error, and the annual management cost.

Q. Are there any issues in the industry that you think might hinder uptake of ETFs?
A. The industry needs to further educate the end client. The reason why ETFs have not taken off in the UK to the same extent as they have in the US and European market is that firstly, distribution in the UK is different. A large amount of the financial advisers receive substantial trail commission for selling retail funds, which they do not receive from selling ETFs.

The retail funds industry also manages more than the ETF industry currently and the advertising is substantially higher. Maybe some of the ETF providers should start advertising and marketing more to the end customer, because these funds are fantastic ways of investing. ETFs have everything ­ liquidity, transparency, and low cost. For a substantial number of people, it is a great way to invest for their core, whereas at the moment, the percentage of a typical person’s portfolio actually invested in ETFs is very small.