For today’s discerning financial and investment professional
ETFs In The Spotlight
February 2018 an IFA Magazine Supplement
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I FA ETF ROU N D TABLE
IFA Magazine ETF Round Table Welcome The Team at IFA Magazine were invited to host a special ETF Round Table in partnership with colleagues at Inside ETFs at their European Conference in London in October 2017. We asked Conor Ó hAonghusa, Director of Audience Development, to introduce this special supplement. 2017 was a record year for ETF inflows globally with ETF assets exceeding $600 billion and marking the 4th year of record inflows. As ETFs become a more important part of the investment landscape so too does ETF education. Inside ETFs has been at the heart of ETF education for over a decade and our first London event in October 2017 saw over 600 financial professionals gather to hear world-leading experts discuss the key issues facing financial advisers today. Our aim is to help simplify this fast emerging investment strategy, bringing new investment solutions to our audience and helping answer their questions/concerns. Having established an open line of communication with UK financial advisers 4 years ago, we have witnessed the evolution of ETF awareness in the UK. The ¨ET what ... ?¨ (literally the most common response to our approach offering ETF education in 2014) of early interactions has been replaced by a clear knowledge that ETFs exist and that they are likely to become an important tool for investors. However, we found that ETF issuers were not communicating effectively with financial advisers. There was a disconnect in what issuers were saying and advisers wanted to know. Before getting to product specifics, most advisers really wanted to get back to the basics of accessibility, understanding and trust. Facilitating a round table discussion where representatives of both sides could begin to listen to each other’s concerns was an initiative we wanted to work and partnering with IFA Magazine was an obvious choice in order to make the session available to the broader adviser community given the importance of the messages. We are grateful to those who participated on the day (shown right) and we hope the publication of the round table format in this special supplement goes some way to ensuring that transparency and greater engagement is encouraged within the financial planning community.
Conor Ó hAonghusa is Director of Audience Development at Inside ETFs, where he has built awareness for leading ETF events across, America, Europe and Asia. Tel: +34 634 414 693
Andrew Walsh is head of UBS Passives and ETF Specialist Sales for UK & Ireland and is responsible for developing and implementing the UBS ETF business, as well as managing client relationships across this region. andrew.walsh@ubs.com
Christine Cantrell is UK Sales Director for ETFs at BMO Global Asset Management. Christine joined BMO to drive the ETF business development in the UK. She has over eight years’ experience with ETFs, most recently at State Street Global Advisors. Tel: +44 (0)20 7011 5247 christine.cantrell@bmogam.com Charles Chami (IFA) has over ten years financial services experience including five years at Morgan Stanley where he specialised in Fixed Income, Commercial Real Estate and Asset Management. Tel: +44 (0)1454 322011 charles@glamis-ifa.co.uk
Next Up By the time you are reading this, the 11th Annual Inside ETFs Conference will have taken place (January 21 – 24) at the Diplomat Beach Resort, Hollywood, Florida. The world’s largest ETF event we look forward to updates from Conor in future issues of IFA Magazine.
IFA Magazine is published by IFA Magazine Publications Ltd, Arcade Chambers, 8 Kings Road, Bristol BS8 4AB Tel: +44 (0) 1179 089686 © 2018. All rights reserved ‘IFA Magazine’ is a trademark of IFA Magazine Publications Limited. No part of this publication may be reproduced or stored in any printed or electronic retrieval system without prior permission. All material has been carefully checked for accuracy, but no responsibility can be accepted for inaccuracies. Wherever appropriate, independent research and where necessary legal advice should be sought before acting on any information contained in this publication. IFA Magazine is for professional advisers only. Full details and eligibility at: www.ifamagazine.com
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Vasudev Patel (IFA) - Akshar Financial Services Ltd Financial Adviser (Restricted Whole of Market) 20 Wetheral Drive, Stanmore, Middlesex, HA7 2HN akshar@btinternet.com
Vijay Desai (IFA) PSD Financial Services Limited 25 Oxhey Road, Oxhey, Watford, Hertfordshire WD19 4QG United Kingdom Tel: +44 (0)1923 223751 office@psdfinancialservices.com
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E D'S WE LCOM E
$5 Trillion, Here We Come ETFs have many advantages but with high stock market valuations the rise of passive vehicles does not come without some concerns The real surprise about the UK’s swing toward exchange traded products is that it’s any kind of a surprise at all. The news that last year’s international asset valuations for ETFs and ETPs grew by a massive 36.3% by the end of December - reaching a colossal $4.83 trillion – will not have raised eyebrows anywhere in Europe, where assets grew by an even more impressive 40.1% during 2017, attaining a total valuation of $802 billion in December. Suddenly, all those assertive predictions of a $5 trillion global ETP capitalisation by the year 2020 seem rather timid. But then, as data researcher ETFGI reminds us, the global total a year earlier had been a mere $3.548 trillion. The extraordinary $1.287 trillion of net additional assets during 2009 represents the biggest growth in assets since 2009 – a year when markets were recovering after the financial crisis, remember. So are we seeing a rebound in net investment, or is it simply that a rising stock market tide is lifting all boats, ETPs included? According to ETFGI’s figures, it’s a little of each. Global net inflows during 2017 rose by 67.4% to reach $653.97 billion, ETFGI says - 67.4% more than net inflows for 2016. The rest of the asset increase will have been down to asset appreciation. Not a bad way to celebrate the 25th anniversary of the first American ETF launch, the SPDR S&P500 ETF, which first saw the light of day on 22nd January 1993. So long, active management What’s causing the current ETF resurgence? Not least, a growing sense that the topping-out of equity valuations in many markets has increased the risks from stock
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selection - and by extension, from active management techniques altogether. Given the choice between a 2% annual management charge and a 0.1% TER for an ETF, which would you choose? And if you were then advised that your ETF would be both highly liquid (unlike many investment trusts) and priced in real time (unlike UCITS), which would you go for? That, of course, is only part of the balance that investors need to assess. The choice remains as to whether asset-backed physical ETFs (i.e. funds that hold real shares or commodities) will be a better fit than synthetic funds where the value rests in a complex of derivatives contracts that ‘ought’ to pay out the equivalent of an asset-backed portfolio, but without the trading overheads. At present, investors are showing a distinct preference for physicals, which extends also to commodity products such as gold and platinum. Higher beta But then there’s the question of higher beta, which is now starting to gain the kind of attraction in Europe that it has long held in the more risk-tolerant United States. The point about higher beta being that it can add a dash of chilli sauce to a portfolio dish that might otherwise seem rather bland. And which can effectively restore some of the excitement of a targeted investment trust to a sector that’s sometimes seen as overly passive – but with realtime pricing and low costs built in! American private investors have long since become used to the highbeta idea of tracking an obscure specialist index of smallcaps, coal miners, start-up funds, tech-widget manufacturers or companies with low credit standings that really
ought to produce better results than conventional major-index trackers. Continental Europeans are also ahead of their British counterparts in this regard – so there’s everything to play for in the UK. Granted, some of the newer high beta entrants demand a clear understanding of risks. There are leveraged ETFs, bond yield tracker ETFs, inverse ETFs that rise whenever valuations fall, and ETFs that aim to exploit strange foreign tax loopholes that you wouldn’t be able to access any other way. Most recently, there have been bitcoin trackers which would have kept the originators of the ETF concept awake at night! Always passive, despite appearances These, however, are the extreme outliers in a marketplace where the general taste is far more moderate and rather less speculative. The point to remember is that an ETF, of whatever type, is always a passive investment, insofar as it tracks its target wherever it happens to go. The skill in choosing an ETF lies in picking the right target to start with, and in understanding the chances of a successful outcome before you lay your money down. For the adventurous investor, that implies a careful consideration of every conceivable risk and outcome scenario – not to mention a careful scrutiny of the various counterparties themselves. For the great majority, however, it’s a matter of trusting to the security of simple trackers which operate on algorithms and which are, in the most literal sense of the word, no-brainers. Michael Wilson Editor-in-Chief
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ETH ICAL ETFS
Ethical ETFs
How Passive Funds are Helping Social Investing Grow Investor demand means there is a growing number of ethical ETFs on offer
Socially responsible investing (SRI) is pushing to the forefront of investors’ minds and exchange traded funds (ETFs) are offering advisers the chance to help their clients fulfil their ethical investing requirements. According to the Global Sustainable Investment Review 2016, $12 trillion of European assets are already invested in sustainable and responsible investment strategies. Of this
total, the majority is held by institutional investors but 22% is owned by individual investors. This proportion has grown exponentially in just a short number of years: in 2014 it was just 3.4%, revealing the extent of the popularity of SRI and responsible investing. SRI ETFs track an index made up of sustainable and responsible companies, such as the MSCI All Companies World Sustainable Impact Index, that identifies companies that derive at least 50% of their revenues from products and services that address environmental and social challenges.
The indices and funds are typically created by exclusionary screening, taking out industries such as tobacco and mining from an index, or by inclusionary screening where they focus on companies that have exceptional environmental, social and governance (ESG) ratings. Speaking at an ETF Roundtable organised by IFA Magazine in London, Andrew Walsh, Head of Passive and ETF Specialist Sales at UBS Asset Management, says the asset manager is the European leading provider of ESG-related ETFs in Europe and theat company has seen increased inflows into SRI focused investments. “Three years ago, a small number had an interest, but we’ve seen a five-fold increase in assets in this suite of products the last two years,” he says. “Historically if you were going to invest ethically, you had to get a fund manager to do the stock picking for you or
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ETH ICAL ETFS
you had to go about avoiding the obvious bad guys. “Across the different regional exposures we’ve gone about creating an ‘all-star’ team which includes the companies with the best ESG profiles across the key 11 sectors. "The methodology effectively delivers the best 25% in each country. This is not simply about stripping out all of the sin stocks, which would remove maybe around 8% of the stocks in an index. The methodology we use from MSCI is far more comprehensive than that”, he says. Growth in the portfolios has been “spectacular”, putting the argument that social investing doesn’t act as a hindrance to performance. “Historically, one would expect to pay a bit away if you’re going to be an ethically-minded investor on the basis that you’ll lose out from excluding the big-dividend paying tobacco companies for example. In fact, increasingly there is academic evidence to show that companies with strong ESG profiles are delivering higher ROEs – especially in Europe,” he says.
says that BMO Global Asset Management does not have any socially responsible ETFs but the share in companies held by the ETFs are used to help promote good governance and ethical practises within them. “At BMO Global Asset Management we have a strong responsible investment offering from our active fund management team, and although we haven’t produced a responsible ETF yet, the assets that we acquire through our passive business helps our active team engage with the companies they have strong views on,” she says. “Their voting rights and influence strengthens with the extra shares that BMO Global Asset Management as a whole owns.”
She says that some investors shy away from ETFs because of what they see as a lack of corporate governance, but that the shares held by ETFs do have an impact. “Some people don’t invest in ETFs because they believe there’s no corporate governance, but building up the assets in our ETF range gives more muscle power to our responsible team engaging with those companies who need to improve,” says Cantrell. “Whenever we get flows and assets into the ETF, that bolsters the amount of assets that we can say we have invested in multiple companies that we’re already engaged with, which are gradually improving their corporate governance.”
“Investing along these lines, many ESG-screened indices have outperformed the standard parent indices.” Growing the shares Christine Cantrell, ETF Sales Director at BMO Global Asset Management,
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SPONS0RE D FEATU RE
Fidelity International launches its first smart beta ETFs Regulatory developments and changing investor preferences are driving demand for ETFs. Fidelity International, well known for its active investing capabilities, is one of the recent entrants into this market. Is this move into smart beta ETFs a natural progression of its core beliefs and what is the ongoing approach? We find out
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Why has Fidelity International chosen to launch the ETFs now?
Demand for passive, smart beta and other systematic strategies has been growing in recent years and is expected to continue to accelerate as investors look for low cost, targeted products that can meet their specific needs. Fidelity International is focused on providing world class investment solutions to meet the needs of our clients. By combining our active investment expertise with the systematic aspects of passive investing, we are able to provide differentiated solutions aligned to the outcomes our clients are looking for.
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Please explain how smart beta strategies work and why you are using this approach?
Smart beta strategies combine elements of both active and passive investing. They seek to define a set of rules that will capture elements of an active strategy but without the full discretion of an active portfolio manager. The strategies are designed to provide access to a particular investment style or theme or to achieve a better risk adjusted return than market capitalisation weighted indices. This is achieved by screening securities for specific fundamental or quantitative attributes and/ or adjusting the portfolio weightings.
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SPONS0RE D FEATU RE
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Smart beta is becoming popular, but how should clients ensure that they understand what they are buying?
Smart beta products can be useful tools to access a strategy or theme but as with discretionary active strategies, duediligence is required to ensure that investors fully understand the positions that the products are taking on and the risks that they are exposed to. To demonstrate this point, we undertook some analysis of existing smart beta equity income indices. We found that in addition to identifying higher yielding stocks, these indices generally have significantly different industry sector exposures compared to the broader market (as represented by a market capitalisation weighted index). These relative sector bets are a consequence of the methodology used to select and weight the stocks, and can significantly influence returns. This is not necessarily undesirable, but investors need to be aware of these sector positions and be sure that they are aligned with their own sector views. If this is not the case, or if they wish to avoid sector biases altogether in their exposure to income-paying stocks, it may be preferable to control sector positioning relative to the broader market.
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SPONS0RE D FEATU RE
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How many ETFs has Fidelity launched?
We launched a range of Quality Income ETFs in 2017. These products provide exposure to the ’quality income’ strategy in four regional exposures: Europe, US, global developed and emerging markets. At the end of the year we also introduced currency hedged share classes to allow clients to get exposure to their desired equity markets without taking on the currency risk.
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Fidelity has chosen equity income as the theme for your first smart beta ETFs. Why this strategy?
Equity income ETFs are by far the largest category of smart beta ETFs and have proved to be a popular, low cost way for clients to boost the yield of their equity allocations. We also feel that this is an area that we can leverage Fidelity’s experience in active management, portfolio construction and risk management to offer differentiated products. We developed Fidelity Quality Income indices which provide exposure to high quality income paying companies.
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SPONS0RE D FEATU RE
Fundamental active insights inform the factor definitions used to identify quality companies. Risk management principles lead to rules that minimise unintended sector, size and country risks. The result is a strategy that provides a consistent uplift in dividend yield but also controls sector positioning and more accurately targets the income exposure that is desired.
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You have talked a lot about sector allocations, why is this such an important consideration?
Income strategies that do not control sector allocations can exhibit significant deviations from the broader market. They will generally be underweight lower-yielding sectors such as information technology and overweight higher-yielding sectors such as utilities. In some cases, these deviations can be more than 20%. This means that the performance of the strategy can end up being driven by the sector positioning rather than the income theme. We were surprised with the extent of the sector deviations in existing strategies and I’d be surprised if all investors holding the products are aware that they are taking on this level of relative risk. We don’t believe that clients will use these products to implement sector views so we wanted to provide a return profile which is more consistent with the broader market whilst offering an increased yield.
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But how much difference can this make?
An example will help bring this to life: in the US, technology stocks performed particularly well in the second half of 2017 and this really impacted the performance of products that were underweight this lower yielding sector. Fidelity’s US Quality Income ETF launched in April 2017. During 2017, the Fidelity US Quality Income Index achieved a return of 5.9% above the index tracked by the largest competitor product while achieving a similar yield. This demonstrates how sector allocations can have a really meaningful impact on performance. Of course, these allocations can work for or against the strategy but we did not want to be exposed to significant relative sector positions and the relative risk that goes with this.
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Does Fidelity plan to launch more ETFs in 2018?
Yes, now that we have the platform in place we plan to launch additional ETFs and index funds this year. These are likely to include additional smart beta strategies and conventional market capitalisation weighted products. We are investigating a number of additional strategies which will be prioritised based on feedback from our clients. The next launches can be expected in the first half of this year. For more information please visit: www.fidelity-etfs.com This information is for Investment Professionals only and should not be relied upon by private investors. This communication is not directed at, and must not be acted upon by persons inside the United States and is otherwise only directed at persons residing in jurisdictions where the relevant funds are authorised for distribution or where no such authorisation is required.
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ETFs I N TH E SPOTLIGHT
ETFs in the spotlight
How Investment is Being Democratised ETFs have many advantages but with high stock market valuations the rise of passive vehicles does not come without some concerns
Competitive pricing and transparency has pushed exchange-traded funds (ETFs) into the spotlight but advisers still have concerns about whether they are distorting the market. ETFs are big business, so much so that they are having increasing sway on stock market movements and raising concerns about whether they are creating distortion in the market. A Bank of America Merrill Lynch report this summer warned that ETFs could be making the market less efficient. ETFs account for nearly a quarter of US stock market trading volumes, up from 20% three years ago. In the report, author Savita Subramanian notes that large cap US equity managers have “the luxury – and curse – of a liquid efficient market” but it was harder to have “an edge on large, well-followed stocks than on smaller, less-followed peers”. “That liquidity is slowly being called into question by the ETF-isation of the S&P 500,” says Subramanian.
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Speaking at an ETF Roundtable organised by IFA Magazine in London, Christine Cantrell, ETF Sales Director at BMO Global Asset Management, says there were four main things that have driven the growth of ETFs: “The passive nature, the competitive pricing, but then also the characteristics that make them different from a mutual fund; the transparency and liquidity.”
but if that’s only driving 25% of your return, why not pay the higher fees in the smaller segment and keep the bulk of the portfolio at a low-cost base?”
Cantrell says it took a long time for the industry to understand the power of the index but that it wasn’t about pitting active and passive management against one another.
“The liquidity does benefit a lot of investors,” she says. “They can trade intraday. Another aspect of the liquidity is around the fact that there are multiple parties trading it at all times. The fact it’s on an exchange is a democratisation, as I feel there’s more competitiveness and you get a fairer price. The public nature obliges everyone to be as competitive as possible.”
“The industry realised you could dissect total return into market returns and anything different to that as alpha,” she says. “It’s taken a long time for this passive approach to take off, but over the previous decades, and realising that the performance of capweighted indices contributes to any portfolio, that was a major driver.
Liquidity issues It is not just cost that is benefiting advisers and their clients, Cantrell also cites the “democratic” nature of ETFs, transparency and liquidity.
As the ETF market has grown, investors now have a greater range of targeted funds to choose from.
“If 75% of your performance is coming from beta, why not just get access to that in a low-cost way?” She adds that she is “not against active management at all,
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ETFs I N TH E SPOTLIGHT
“There has been more product development, whether it’s big bulk beta or narrowing it down to small-cap or midcap in financial or technology sectors,” says Cantrell. “There’s also more choice to invest in factors such as quality or high dividend. As it’s a vehicle that suits so many people, why not focus on it?” Despite the positive attributes of ETFs there has been some concern, not just from Bank of America Merrill Lynch, about whether ETFs will help or hinder investors in a market crisis. Cantrell argues that the liquidity offered by ETFs means investors will “be able to get in and out in a difficult market environment”.
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Vijay Desai, Founder of PSD Financial Services in Watford, says ETFs have a role in “portfolio construction and wealth management” but says he was concerned by the “tsunami of funds going into ETFs”.
High valuations have been of particular concern to investors in both the UK and US, with many making references to the tech crash and Black Monday, and whether companies can justify the slow push up in valuation.
“Everybody is going in there and it’s distorting the actual indices themselves,” he says. “When you have huge amounts of funds going in…the valuation of those companies [in the indices] is excessive.”
Desai says the huge amount of money going into stock markets via ETFs is “a reason why markets seem irrationally high”.
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ETFs I N TH E SPOTLIGHT
“We use ETFs but it reflects where growth goes into everything,” he says. “This is where some of the active fund managers go against the type and add value. There has to be a mix of the two…a lot of the general public, particularly in the US through pensions, my own family, have piled into ETFs.” It is not only ETFs that can cause distortion in the market, argues Andrew Walsh, Head of Passive and ETF Specialist Sales at UBS Asset Management. He says within actively-managed funds there was a large overweight to large companies such as Apple and Google. “A lot of these big active funds are putting money into these big companies,” he says, adding that there were large overweight positions to tech stocks in these" “If you, as an active manager, are underweight say, Apple and Google, you’re running a massive risk of underperforming with the way those stocks have been running. If instead, you’re heavily overweight in the smaller stocks in your benchmark index then one must be cognisant of the risks you are running of underperforming.".” He adds that the “biggest crimes” are the “index hugger active managers charging 1.5%”. “Overall, let's not forget that there is a lot of money in the world piling into the equity market. That’s forcing valuations to go higher. This isn’t just about flows into passive investments” Democratising investment The democratisation of investment that has come about via ETFs, where all investors regardless of size receive the same price and access to market, is positive for those investors who have smaller pots to invest.
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Vasudev Patel, Director at Akshar Financial Services in Harrow, says there are too many people in the UK with cash savings that are being eroded and ETFs provide them with an easy-to-understand and cheap entry point into investing. “There are so many people [with their money in] a cash ISA and money lying on the side-lines that is not invested,” he says. “ETF is the correct first step for those people to transfer their savings [into an investment]. If you look at 2007 onwards, cash has not performed well [but] those who took the risk [of investing] have doubled their money.” Data from HM Revenue & Customs (HMRC) to the end of August 2017 shows there were 11.1 million ISA accounts subscribed in the tax year 2016/17 versus 12.7 million in 2015/16. Even though the number of cash ISAs fell 1.6 million over the time frame, and the number of stocks and shares ISAs rose slightly, cash ISAs still made up 77% of the subscribed accounts. Around £62 billion was subscribed to ISAs in 2016/17, down £18 billion on the previous year. The total ISA market was worth £585 billion in 2016/17 and the holdings were split almost equally between cash at 46% and stocks and shares at 54%. However, HMRC notes that the value of holdings rose 10% in 2016/17 compared to the previous year but that was “driven by an increase in the market value of funds held in stocks and shares”, which increased 20% compared to the year before. Patel adds that part of the problem is regulation and the fact the Financial Conduct Authority (FCA) “shut the door on the advice market”.
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ETFs I N TH E SPOTLIGHT
“I think there’s a lower end of the market; the middle-income group, people sitting on ISAs [who would benefit from ETFs],’ he says. He notes one client with £60,000 in a cash ISA that was earning no interest who is a “lower income, middle class person”. “I’m an IFA, so I look at people sitting on cash that’s not invested [and think]: when things improve, how much are they losing out on? I think there’s a window of opportunity for ETFs to offer [a way into investment] to ordinary people.” Spotlight on cost Retail investors have become particular fans of ETFs due to their low-cost nature, something brought to light by the FCA focus on ensuring investors are aware of just how much they are paying for their investments. Walsh says the focus on cost has not only refocused investors’ minds on how much they are paying but pushed the active fund management industry to reassess just how much they charge. “For a long time the active world has been there, digging in their heels and living in denial about the rise of ETFs, and now, there appears to be more of a shift to trying to do something about it and go about reducing the OCF charges,” he says. “If an ETF is prices at 0.25% OCF per annum versus 1.00% [for an actively managed fund], it’s a no-brainer about where you go. [Actively managed funds] are now coming down to a more competitive pricing structure…The world has changed and it isn’t going back.” Cantrell says technology has helped to drive down the cost of investing and market research.
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“If you’re talking about revolutionising how people invest, it’s about the rise of technology and how things evolve over time,” she says. “Now that we have a greater efficiency of technology, instead of an active manager who spent so much time going through the balance sheet – if that’s now all systemised and produced at a lower cost, why shouldn’t people benefit?” Advisers agree that ETFs have their place in a client portfolio, although to what level depends on the preference of both the adviser and client. Desai says it is the adviser’s job to “spot the rascals” hugging the index and identify the best time to take advantage of shrewd stock-picking. Patel says: “I understand... that there’s a place for ETF but you have to select the right one for the client as there are so many.” Paul Wilson, Chairman of IFA Magazine and former adviser, says advisers need to be aware that when alpha is being generated “everyone takes their little bit from that”. “With the low return environment, the person at the bottom is the client and some of their returns are pretty poor,” he says. “When you look at the returns people are taking out, it’s quite low...With ETFs, there’s such a value to be delivered with a net benefit to be delivered to the client, that’s the message. ETFs have a huge amount of choice, they’re good value, and you can pick any interest area. That makes it perfect for an IFA to add value.”
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TH E RISE OF ETFs
The rise of ETFs
Why Advisers Need to Get on Board The UK market is lagging the US in terms of ETF take-up but advisers will need to take heed of this fast-growing sector Replicating the US success of the exchange traded fund (ETF) market in the UK will take the combined effort of advisers, providers, platforms and the regulator. Figures from ETFGI show that in 2006 assets held globally in ETFs totalled $580 billion but just over a decade later and they have swelled to $4.3 trillion. However, the huge growth in the market is mostly due to inflows in the US, which according to some estimates accounts for 70% of the market. While the take up of ETFs in the UK has been encouraging it is yet to replicate the exponential growth seen in the US. The ETF Forum, an independent partnership of leading ETF providers, is aiming to build a better understanding of the investments and educate advisers on how to use ETFs to build and enhance a well-diversified portfolio. Speaking at an IFA Magazine ETF roundtable in London, Christine Cantrell, ETF Sales Director at BMO Global Asset Management, which is part of the forum, says it is focused on “pure education” at its roadshows rather than sales pitches.
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“We had around 120 attend during the summer roadshow and it looks like a similar number for our winter roadshow this year,” she says. “We’re trying our best but we’d love more engagement.” Despite efforts to increase adviser understanding of ETFs, the slow take-up of the investment may be a purely practical problem. Getting on board Charles Chami, Director and Independent Financial Adviser at Glamis IFA in Bristol, says one hurdle for advisers is the range of investments offered by their platform. “The platforms are extremely useful tools in providing choice in one place but, by their nature, if you’re using it quite heavily, you’re subject to the choices of that platform provider,” he says. “If they don’t have access to ETFs then the client might not either.” Conor Ó hAonghusa, Director of Audience Development at Inside ETFs, says ETF sales by financial advisers on adviser platforms are just 1% of the market.........and that those advisers who do understand
what ETFs are and how to use them have “an access issue”. “The platforms are the main hurdles, if they don’t provide access to ETFs or if they treat them differently from a cost perspective,” says Cantrell. “Platforms need to transition to a state where ETFs are on a level playing field with mutual funds.” Cantrell adds that the platforms that first offered ETFs often treat them like stocks and shares “so it was more costly to trade ETFs compared to mutual funds” and that led to subdued demand from advisers. “If investing in an ETF on a platform is more similar to a mutual fund transaction, IFAs can still benefit from the wider choice and lower cost of many ETFs, and this is beginning to be the case” she says. Although Cantrell points out that it is hard for platforms to “quantify demand” when ETFs are not available on a certain platform. For Chami, platforms failing to offer a full range of investments is an issue from a client outcome perspective.
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TH E RISE OF ETFs
“Client outcomes trump everything,” he says. “Even going through our annual platform research, if platforms continue not to have ETFs, that will be a larger and larger negative against those platforms.” He says there are barriers to using ETFs on some platforms either because they do not provide access at all or the increased administration burden placed on advisers when investing their clients’ money. “For example, a number of platforms require each client to sign an additional risk form or approval to be able to buy ETFs,” says Chami. “It’s a relatively simple thing to do but I think it’s an unnecessary barrier. It’s also worded in a way that a large company would word things, which is sometimes less than helpful...it’s an example of making it harder for IFAs.” Paul Wilson, Chairman of IFA Magazine and former adviser, says ETFs fall into the “classic chicken and egg situation”. “We have a product that we agree is great, why wouldn’t you use it?” he says. “There are untapped markets in the lower end of the market and it’s not happening as it’s not in the adviser’s comfort zone. For some it is about risk. If you perceive ETFs to be risky, you won’t do those.” He says the message that ETFs are “mainstream” has to go out to advisers.
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Onerous regulation For Vijay Desai, Founder of PSD Financial Services in Watford, part of the problem around risk is onerous regulation. He also blames regulation for the slow take-up in ETFs and why growth in the UK hasn’t been as rapid as in the US. He notes that in the US, 401k pensions - which are US self-directed pensions - are mainstream and individuals, and the regulators, are comfortable picking their own funds. “The UK regulators have considered [self-directed pensions] to be a risky process, so the advisers and the advice process is much more long-winded,” says Desai. “The regulators consider ETFs...as riskier.” Desai adds that the Financial Conduct Authority (FCA) needs to be more “engaged” with ETFs but that it was up to the ETF providers to initiate that engagement by making the risk profile of the investments clearer, more in keeping with mutual funds. “They classify ETFs as a risky product,” he says. “We have to have our client business records; in the last couple of years, we’re now required to list all the funds on our business records
[so] that can be reported to a compliance department or if the FCA request records. “For mutual fund, each is individually rated based on the component of the investment. The ETF [industry} has a blanket attitude. The ETF industry needs to engage with the regulator and show they have different risk factors.” Doing the due diligence It is not ratings where the FCA is focusing its energy when it comes to ETFs, says Cantrell, as advisers will have to demonstrate why they are not using or considering these types of investment. “Due to the most recent FCA market study, IFAs will be asked why they are not using more passives,” she says. “My understanding is that there is a shift to a more positive view on passives.” She also disputes that advisers are using ETFs, stating the average size of an ETF trade on the London Stock Exchange is £37,000. “That shows that it’s not exclusively large, institutional trades happening in ETFs,” she says. As with any investment, performance is high on the agenda when it comes to assessing client suitability and one criticism levelled at the ETF is the ‘guaranteed underperformance’ in difficult stock markets. It cannot be disputed that ETFs will go down when the market does but Cantrell argues that at least the adviser and the client knows what the underperformance will be, whereas the same cannot be said for active fund management.
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TH E RISE OF ETFs
“You know what you’re going to underperform by, as you can see the cost and the tracking difference,” she says. “At least you are comfortable in knowing it will be around that level whereas an active manager will have more deviation. It’s whether you’re comfortable in taking that range of deviation.” Andrew Walsh, Head of Passive and ETF Specialist Sales at UBS Asset Management, says pitting ETFs against active funds comes down to “idealism versus realism”. “There’s a wide array of data,” he says. “S&P and other research houses show that many active funds are underperforming their respective indices which they track, after costs. An ETF isn’t free either but are usually considerably cheaper than active funds. Ultimately, it’s kind of idealism versus realism. I see us as the realism side of the equation.” Cantrell adds that the range of ETFs now on offer means active fund managers have a plethora of indices they can compare themselves to, and are able to find a suitable comparison. “With the evolution of indices, there are indices following a value or low volatility strategy,” she says. “Why doesn’t the active manager compare themselves to one of those indices? “If you want to compare performance to the marketcapitalisation weighted indices, some ETFs can outperform those indices.” Chami says it can be difficult to use indices that are not as readily available for comparison, especially when discussing fund performance with clients who want up-to-date news. “We will often use the FTSE 100 for performance comparison,” he says. “People understand the FTSE 100; it’s quoted on the news every day, some industry benchmarks are not as easy to understand.”
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Thinking longterm However, Chami notes easy comparison are not the main priority for advisers who are working long-term with clients and who want to ensure an investment is safe before exposing them to it. “Our timeframe for dealing with our clients is years, and often decades,” he says. “There have been a number of events in the industry where things have gone wrong, your nightmare as an IFA is something really going wrong and you don’t want it to affect your clients.” He says the concern about a potential problem with an investment means that sometimes IFAs are slower to react and may be the reason the uptake in ETFs has not been immediate. “If IFAs are slower to move, it could be they’re operating over a longer timescale, and we can wait for a sector to prove itself,” says Chami. “You’re wondering why it doesn’t move quicker; the age profile of your average IFA is a bit older and they’ve seen a lot of things go wrong and so are cautious. They don’t want it to be them and their client [who are affected].” Taking risks is part of an adviser’s job and can never be avoided, but it can be minimised with strong due diligence. For adviser Desai the underlying investments are key to determining whether an investment is suitable for his clients or not. “I never just look at any fund or ETFs, I look at the underlying investments,” he says. Desai says that ETF take-up may increase over the next six months due to the reporting requirements that will come into affected and advisers will no longer to justify costs, risks and returns. Cantrell says due diligence can be difficult in active management as it may be difficult for an adviser to justify more risky underlying
investments in a fund. However, she argues that ETFs are by their nature transparent because advisers “know the rules in place”. “When your client comes to question you and questions the under or outperformance of the portfolio, you may not know why an active manager is holding a Russian bond but, with an ETF, the rules are so clear,” she says. “When you look at smart beta ETFs, the methodology is constant so you don’t get style drift.” Desai adds that he is concerned about the potential for a “perfect storm” to create a downturn “in the next 18 months” and he has to think about how to manage their downturn for his clients. Walsh says that ETFs follow the market so will track down but the scale of the underperformance against the index is a known. “With an ETF, if the market goes down, our ETFs are supposed to go down with the market,” he says. “If the market goes down 20%, our ETFs should be down 20.2%... We’re there to track an index.” The new breed of smart beta ETFs, which use alternative criteria to build an index such as size, value and volatility instead of market cap weighting, can deliver outperformance but Walsh adds that this may not be every year. “Smart beta doesn’t mean it will outperform every single year, but these tools have been proven to provide superior long-term performance against standard market-cap weighted indices,” he says.
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Variety Exchange Traded Funds, from equities to commodities. UBS ETF. / ubs.com ts etf-insigh
For professional investors only. For marketing and information purposes by UBS. This document has been issued by UBS AG, a company registered under the Laws of Switzerland. Issued in the UK by UBS Asset Management (UK) Ltd, authorised and regulated by the Financial Conduct Authority. This document is for distribution only under such circumstances as may be permitted by applicable law. The products or securities described herein may not be eligible for sale in all jurisdictions or to certain categories of investors. Source for all data and charts (if not indicated otherwise): UBS Asset Management. Š UBS 2018. The key symbol and UBS are among the registered and unregistered trademarks of UBS. All rights reserved.
SPONSORE D FEATU RE
Mixed outlook for commodities in 2018 Advisers looking for value in the commodities sector may wish to consider exposure to industrial metals within clients’ portfolios argues James Butterfill, Head of Research, ETF Securities Commodities have enjoyed a great start to 2018, from thier low point in mid-December they have rallied 6.5%, thier performance has been broadbased too, driven not only by the Iran issues inflating the oil price but a rally in industrial/ precious metals and agriculture. We are wary of some who are interpreting this as being a positive sign for broad commodities this year. Commodities as an asset class are a very heterogeneous group and we expect varied performance from each.
Gold Although we expect the Fed to continue to tighten policy, we think the downside risks to gold prices are limited because real interest rates are likely to remain depressed as inflation gains pace in the US. However, a shock event, such as an equity market correction, could force gold prices higher. On balance we see little change in gold prices in the coming year. Investors appear to be optimistic about gold despite the rising interest rate
environment, we believe this is due to investors now seeing gold as an insurance policy from geopolitical concerns rather than investment. (Figure 1) Industrial Metals We expect the most interesting commodity in 2018 to be industrial metals. They are likely to benefit the most from improving emerging market (EM) growth, at the same time we expect supply to remain in deficit in 2018 as the lack of investment in mining infrastructure continues to bite.
Gold Price Forecast
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Source: Bloomberg, ETF Securities, data available as of close 20 November 2017. Historical performance is not an indication of future performance and any invstments may go down in value.
Figure 1 - Gold Price Forecast
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Source: Bloomberg, ETF Securities, data available as of close 20 November 2017. Historical performance is not an I FAmagazine.com indication of future performance and any invstments may go down in value.
SPONSORE D FEATU RE
Miners Margins vs Supply/Demand 20%
3,500
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-2,500 2% 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 Figure 2 - Miners Margins Vs Supply/ Demand
EM demand is crucial for commodity markets as they represent 70% of industrial metals demand. In this respect, we expect any weakness in commodity prices to be largely offset by solid demand growth, again led by China. Although concerns remain over the build-up of debt, Chinese policymakers have continued to show a willingness to support the financial system with stimulus to ease financial conditions. Since industrial metal prices began to fall in 2011, capital expenditure by miners collapsed. In mid-2017 capital expenditure by the largest 100 mines was 60% lower than in mid-2013. Given the long lag times behind investment and completion of mines, we don’t expect the tightness of mine supply to reverse any time soon. Miners seem to have been cautious to increase spending as they wait for
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the price recovery to prove sustainable. Historically we have seen about a yearlong lag between a recovery in price and a recovery in capital spending. It is likely in 2018, as commodity prices continue to rise, that we see capital expenditure growth turn positive, although the damage of 4 years of lack of investment in to mining infrastructure has already occurred and is why industrial metals remain in a supply deficit. (Figure 2)
We expect the most interesting commodity in 2018 to be industrial metals, They are likely to benefit the most from improving emerging market growth
Historically we have found that metal markets begin to move towards a balance two years after miner profit margins hit rock-bottom. Miner margins fell to a low of 2% at the beginning of 2016 and since have recovered to just over 7%. So if we see a repeat of historical patterns, we should see supply begin to improve in late 2018, but it could take years to move back into balance.
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BALANCI NG ETFS
Weighing up ETFs against other por tfolio options When it comes to portfolio construction and asset allocation, which areas do ETFs tend to have the advantage? Peter Sleep, Senior Investment Manager, Seven Investment Management (7IM) gives his opinion on how advisers can seek the best value approach for clients
A perennial question facing many advisers is how they might put together an investment portfolio for clients and use active funds or ETFs. Most advisers will agree that this is a bit like asking how long a piece of string is. It certainly doesn’t have to be an either / or scenario – as our own portfolios testify. But frustratingly, the answer is not easy and it inevitably involves a lot of tooth sucking and head scratching. We do this because it is a difficult question and there is no clear answer, not because I want to be enigmatic or evasive. Client first Advisers will know all too well that putting together a portfolio is a very personal thing. It will depend on your client’s time horizon and whether they are willing to accept losses in exchange for long term returns - even then there is a high degree of uncertainly to build in. This is why advisers spend so much time with risk tolerance questionnaires. It is also where they can really add a lot of value. Perhaps one of the great conundrums facing advisers is the fact that whilst past performance is absolutely no guide to future returns, we can still draw on the past to try to gauge how that might inform the future.
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Some of the best mathematical and computer science people in the world work in the savings and finance industry and I think they will all agree that there are no absolute correct answers for any investor or their adviser. For the purposes of this article, I shall assume that you have had a long hard think about your client’s personal situation and that they have a very long time horizon, but that they do not really want to take a great deal of risk. A “balanced” investor might invest 50% of their portfolio in bonds and 50% in equities. Even though this sounds conservative, nearly all the ups and downs you suffer will probably come from the equities in the portfolio. The risk experts at 7IM tell me that about 85% of the volatility you will experience will probably come from the equity components of your portfolio. An adviser can really add value in this area by explaining the risks upfront and by guiding their clients through the market downturns.
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BALANCI NG ETFS
Active funds or ETFs?
Advantage active funds?
Whether you should use active funds or ETFs seems to be the next question. Here I think personal preference is again key. Whilst with any age-old debate, there’s always that element of ‘six of one and half a dozen of the other’, there is much evidence to suggest that as a group, active managers find it difficult to add value. However, on the other hand, some might argue that you are guaranteed to underperform by the fees with an ETF. At least with an active manager you have the chance of outperforming and there is some value in that option.
High yield, Emerging Market bond and convertible bond ETFs are generally priced at levels close to the active managers and these are areas where good fundamental research by an active manager can really pay off, so an adviser might want to spend some time trying to find a good active manager.
Advantage ETFs? At 7IM we tend to sit on the fence on the active versus passive argument. It is very hard to find an active manager who consistently outperforms in areas like government bonds, so it seems like a good idea to save your time and reduce fees by selecting ETFs in these areas. A holding in high grade, developed market global bonds is a key component of most portfolios, despite their low yields. Not always, but usually, when equity markets go down, high grade bonds generally go up and act as a bit of a cushion for your portfolio. I say this knowing that this has not always been the case. In the bad old, high inflation days of the early 1970s, when bonds were known as “certificates of confiscation”, bonds were not great for balanced portfolios. Expect to pay between 0.1% and 0.2% for a government bond ETF and if there is an overseas component you may decide to look for a hedged ETF. To hedge or not to hedge is not clear cut, as hedging removes exposure to some of the world’s safe haven currencies like the US dollar and the Japanese yen, but on balance we believe that bonds are low risk assets and removing currency volatility through hedging can be a good thing. When it comes to corporate bonds we think ETFs tend to win out. Generally, it is very hard to find an active manager in this area and an adviser might prefer to spend their efforts in other areas with greater added value. An ETF will cost around 0.2%, whereas an active fund will cost twice that.
Equities are an area where an adviser can add value by trying to find active managers. This can be done by selecting a global equity manager or by a series of UK and country / regional portfolio managers. Historically investors have struggled to find active managers in the US – the argument being that the markets are “too efficient” for active managers to outperform. The reality may be that the market has been led higher by a few very large tech companies, whereas portfolio managers tend to prefer smaller stocks with room to grow. If you think that the large tech companies may have had their day in the sun, then it could be worthwhile looking for a US active manager who invests in smaller US stocks. The same is true for the other major markets like Europe, Japan and the Emerging Markets. We think it is generally worth spending time to find an active manager in these areas. I have given a personal outline of how I think an adviser might combine ETFs and active funds. There is a lot of room to be creative within this outline by perhaps including some of the ethical or gender equality ETFs that are now emerging and gaining traction. However, perhaps the greatest added value comes from the adviser’s relationship with their clients. By ensuring that they are in the correct risk category and keeping those clients invested in the market through thick and thin, ensures that they can benefit from the long term returns they need, in order to meet the all-important objectives of their financial plan.
Peter Sleep 7IM Senior Investment Manager, Equities Peter joined 7IM in 2007. Having qualified as a chartered accountant, Peter audited company accounts, before joining Citibank as an internal auditor. After three years in that role, he worked for 11 years in Citibank/Citigroup as fund manager and analyst. Prior to joining 7IM he worked as an analyst at Man Group. Specialist areas/responsibilities: portfolio strategy, quant funds, investment auditing, alternative assets / methodologies and Japanese equities.
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CS
CoinShares
FORTUNE FAVOURS THE BOLD BUT YOUR CLIENTS DON’T NEED BOLD THEY NEED YOU TO DO THE RESEARCH UNCOVER THE FACTS ON CRYPTO-ASSETS COINSHARES.CO.UK
WITH OVER £1 BILLION IN CRYPTO-ASSETS ACROSS A FAMILY OF EXCHANGE TRADED PRODUCTS, COINSHARES GROUP IS THE EUROPEAN LEADER IN CRYPTO-FINANCE. FIND OUT WHY AT COINSHARES.CO.UK
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£1 BILLION FIGURE CALCULATED ON CLOSE OF MARKET 10-JAN 2018 | COPYRIGHT © 2018 COINSHARES | COINSHARES (UK) LIMITED IS AN APPOINTED REPRESENTATIVE OF SAPIA PARTNERS LLP, WHICH IS AUTHORISED AND REGULATED BY THE UK FINANCIAL CONDUCT AUTHORITY (FRN: 550103). THIS DOCUMENT HAS BEEN PREPARED AND ISSUED BY COINSHARES (UK) LIMITED AND IS BEING PROVIDED FOR INFORMATION PURPOSES ONLY. IT IS NOT INTENDED AS AN OFFER OR SOLICITATION TO ENTER INTO ANY PROPOSED TRANSACTION OR INVESTMENT. INVESTORS’ CAPITAL IS AT RISK, AND I FAmagazine.com INVESTORS SHOULD ONLY INVEST IF THEY ARE ABLE TO AFFORD THE LOSS OF ALL CAPITAL INVESTED. THERE IS NO GUARANTEE THAT THE INVESTMENT OBJECTIVES WILL BE ACHIEVED AND PAST PERFORMANCE SHOULD NOT BE CONSTRUED AS AN INDICATOR OF FUTURE PERFORMANCE.
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GLOBAL ADVISE RS
3 Concepts Fundamental To Understanding Cryptocurrencies By CoinShares Research Team
Many traditional investors are intrigued by cryptocurrencies, but it’s difficult to determine where to start and what trends to watch. While bitcoin has captured headlines with its meteoric price increase and volatility, there are more than 1,000 other cryptocurrencies and crypto-assets; with around 50 more initial coin offerings hitting the market each month. Analyzing these can be challenging compared to conventional stocks, bonds, options, and futures. At CoinShares Research, we aim to help separate the signal from the noise, and provide fundamental investment research for crypto-finance investors.
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By way of an introduction – let’s start with a quick education on 3 core crypto-asset concepts. What is a Crypto Coin? Cryptocurrencies and cryptoassets are denominated in coins, most of which are mined as a part of the transaction verification process. Mining exists to prove ‘loyalty’ to a system by requiring provably expensive input work in order to be allowed the privilege of verifying transactions (for which miners receive newly minted coins as a reward). As more and more miners compete for the freshly minted coins, the difficulty level automatically resets such that the
block verification times always average out to the same length of time. More miners means a more secure protocol and an increased cost of “forging” coins by tampering with the transaction history. Traditional investors might conceptualize this as mining gold in a world where gold becomes increasingly difficult to mine as the remaining finite supply dwindles. What is a Crypto Exchange? Cryptocurrencies are traded on various exchanges. These are online platforms that enable a person to exchange one cryptocurrency for another crypto or fiat currency.
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GLOBAL ADVISE RS
One could think of these exchanges like traditional stock exchanges, currency exchanges, or brokers, but they aren’t typically regulated by governments or insured in any way. Needless to say, investors must ensure that they’re doing business with an exchange that is secure and reputable. Some of the most important factors to consider when evaluating a cryptocurrency exchange include: • Liquidity – How liquid is the order book of the exchange? • History – Is the exchange credible and secure with a strong track record? • Regulatory Exposure – Is the exchange regulated by any governments, or do they have self-imposed regulations? What is a Cryptocurrency ‘Network’? The network represents the group of people using the coin, mining the coin, relaying and verifying transactions, and maintaining the underlying software. Traditional investors should consider a cryptocurrency’s network characteristics for the same reason that they wouldn’t invest in a company just because of its market capitalization alone. An illiquid penny stock could have a large market capitalization, but that market capitalization is meaningless beyond pure
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speculation if there is no underlying business to support it. A cryptocurrency’s network can be, to some degree, compared to a company’s operations – it’s the valuable asset behind the hype. Some important factors to consider when evaluating cryptocurrency networks are: •
Mining – What are the relative sizes of the mining networks between coins? Are they growing?
• Creators – Who are the developers supporting the cryptocurrency? How is new code created? What is the governance model? • Technology – What type of cryptography does the cryptocurrency rely upon? Is the technology experimental or established? The Bottom Line Investors have become increasingly interested in cryptocurrencies, but it can be (and is) overwhelming to analyze them from an investment standpoint. That’s why we have built a professional research arm to help investors understand the complex dynamics of cryptocurrencies and help them make better investment decisions. To see the type of research we offer, read our most recent research here: H2 2017 Crypto Report.
Disclaimer
Coinshares (UK) Limited is an appointed representative of Sapia Partners LLP, which is authorised and regulated by the UK Financial Conduct Authority (FRN: 550103). This document has been prepared and issued by Coinshares (UK) Limited and is being provided for information purposes only. It is not intended as an offer or solicitation to enter into any proposed transaction or investment. Investors’ capital is at risk, and investors should only invest if they are able to afford the loss of all capital invested. There is no guarantee that the investment objectives will be achieved and past performance should not be construed as an indicator of future performance. Crypto-currencies can be extremely volatile and subject to rapid fluctuations in price, positively or negatively. Investment in one or more crypto-currencies may not be suitable for even a relatively experienced and affluent investor. Each potential investor must make their own informed decision in connection with any such investment (after having sought independent financial advice thereon).
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