For today’s discerning financial and investment professional
SUPPLEMENT A G u i d e t o E x c h a n g e Tr a d e d F u n d s
February 2019
Februar y 2019
Introduction SPOTLIGHT ON EXCHANGE-TRADED FUNDS
IFA MAGAZINE ETF ROUND TABLE DISCUSSION
The use of exchange-traded funds (ETFs) has been growing in popularity across the globe amongst professional advisers, asset managers and investors for many years. Investing in ETFs provides an effective and alternative approach to using unit trusts, OEICs or investment companies, with their low cost structure providing considerable appeal. This is particularly important given today’s regulatory climate and also as part of the drive to reduce the overall costs of running an investment portfolio.
In November 2018, we invited a number of industry experts to take part in a round table discussion on the use of ETFs which we held in London. The round table participants were as follows:
Given the growing interest in passive investing, and the considerable efficiencies and transparency that the use of ETFs brings to asset allocation and investment management, the importance of this dynamic investment class cannot be overlooked by advisers, investment managers and paraplanners looking for effective investment solutions for clients’ portfolios. In this light, this special supplement focuses on particular aspects of advisers’ use of ETFs and includes articles with expert insight and opinion on some of the practical considerations involved.
From the considerable detail which was discussed during the round table session, we have summarised some of the key points into three of the articles which feature in this supplement. The articles on pages 10 to 17 all relate to the discussions held at the round table event. From the discussions we can conclude that ETFs have become more sophisticated and can be used for exposure to a range of different themes and factors in a low-cost, liquid way, all of which underpins their appeal. With ETF issuers providing effective passive vehicles and also doing the deep research into the individual stocks held within other funds, it is clear that their popularity appears to be set to grow still further in 2019 and beyond. We hope you find this supplement of interest. Sue Whitbread
PARTICIPANTS IN THE ETF ROUND TABLE LONDON JOHN BARRASS DEEPUTY CEO | PIMFA
SHEENA GILLETT PR AND COMMUNICATIONS MANAGER | PIMFA
CHRISTINE CANTRELL DIRECTOR ETF SALES | BMO GLOBAL ASSET MANAGEMENT
HOWIE LI HEAD OF ETFS | LGIM
TONY CATT FREELANCE COMPLIANCE CONSULTANT
ALEX SULLIVAN MANAGING PARTNER | IFA MAGAZINE PUBLICATIONS | CLIFTON MEDIA LAB
PAUL WILSON CHAIRMAN AND MANAGING PARTNER | IFA MAGAZINE PUBLICATIONS | CLIFTON MEDIA LAB
IFA Magazine is published by IFA Magazine Publications Ltd, Arcade Chambers, 8 Kings Road, Bristol BS8 4AB Tel: +44 (0) 1173 258328
Editor
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IFA Magazine
‘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. The value of investments and the income from them can go down as well as up and you may not get back the amount originally invested. IFA Magazine is for professional advisers only. Full details and eligibility at: www.ifamagazine.com
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DISRU PTIVE TECH NOLOGY
Februar y 2019
Finding potential investment opportunities in
DISRUPTIVE TECHNOLOGY How can advisers and paraplanners capitalise on the continuing developments this exciting sector has to offer for client portfolios? L&G ETF, part of Legal & General Investment Management (LGIM) highlights some of the threats and opportunities which exist as well as some effective solutions
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ur world is being transformed as a new wave of innovation, often technology-led, challenges every aspect of how we live and work. From the spinning jenny and the steam engine to the wireless and the Ford Model T, there are countless examples of small innovations that have ushered in profound social and economic change. Driving these technological advancements is the unending quest for productivity improvement. For investors, this enormous trend could be creating new investment opportunities, offering exposure to potential growth strategies rather than traditional equity investments. In some cases, technological advances are creating entirely new industries that would not have been feasible 30 years ago. “We tend to overestimate the effect of a technology in the short run and underestimate the effect in the long run� is the observation of Roy Amara, a researcher and
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scientist who worked at Stanford. The growing use of data for technological advances, the drive for efficiency and the quest for sustainability are together shaping our future society. To identify these investment opportunities, it is perhaps helpful to separate these major technological advances into separate groupings.
Investors can be blindsided by technology risks, from smaller disruptors or from other industries, and even well-understood technologies can have unexpected impacts
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ROBOTICS, AUTOMATION AND AI From Amazon’s Alexa to Google Assistant, automation technologies are becoming increasingly deployed in all aspects of our lives. As a result, the robotics and automation sector is expected to be worth $1.2 trillion by 2025 (Myria Research, 2015). Increasing adoption of sophisticated robots, enhanced by artificial intelligence (AI), is fast becoming an instrument of profound change that is likely to leave a lasting impact on global productivity and future economic sustainability. The possibilities yielded by AI apply across every sector. In our view, the real beneficiaries of the growing capability of AI will be the companies that can combine technical capability and large datasets with the crucial ability to deploy AI at scale in their core businesses. However, the scale providers of AI capability – the large-cap technology players such as Amazon, Google, Microsoft, Facebook, Alibaba, Tencent and Baidu – are, once again, front and centre of this profound long-term investment theme.
Cyber-attacks pose a growing threat to governments, companies and individuals who are growing ever more concerned about security, financial and reputational damage. Needless to say, the IT security market is currently booming. Having seen exponential growth in these past few years, this looks set to continue as government regulation, increased corporate focus and the growing complexity of threats fuel demand. Advisory firm Gartner predicts total worldwide spend on security products and services will hit around $100 billion this year and 8% forecasted growth per annum. BATTERY TECHNOLOGY
CYBERSECURITY
One of the things that stand out about electricity as a commodity is that it is difficult to store. New developments in battery technology are changing the way we transport and power the world, with innovation happening all along the value chain. Significant progress has been made to improve the energy density, price, lifeline and safety of batteries while mitigating the impact on the environment.
Multiple high profile cyber-attacks highlighted the significance of this issue last year. Ransomware isn’t going away, nor is it slowing down. In a connected world, no business or industry should consider themselves immune from attack. As more data, systems and people connect digitally, vulnerability is on the rise.
One of the most public examples was the installation last year of the world’s largest lithium-ion battery in South Australia. Designed and built by billionaire Elon Musk’s Tesla company, the 100-megawatt battery will be used to store renewable energy so as to avoid a repeat of the previous year’s state-wide blackout due to storms.
THE CURRENT SMALL AND MEDIUM ENTERPRISE (SME) IT SECURITY MARKET IS A $40 BILLION OPPORTUNITY
$50,000
PRODUCT REVENUES ($M)
$45,000 $40,000 $35,000 $30,000 $25,000 $20,000 $15,000 $10,000 $5,000 $0 2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
SOURCE: DC WORLDWIDE
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Musk had promised on Twitter that if the battery was not built within 100 days, the state would receive it for free.From applications such as electric vehicles (EVs) and consumer electronics to stationaries like grid storage, battery storage technologies are currently experiencing a growth in investment, research and production. E-COMMERCE LOGISTICS The ease and convenience of online shopping has led to an unprecedented change in the retail business landscape over the last decade. The growing popularity of ecommerce and greater internet connectivity have driven sales volumes and revenues to an all-time high. Since Amazon acquired Wholefoods, strategic priorities have shifted. Online penetration continues to grow as technology breaks down old barriers. Whilst grocery has been slower to shift to online relative to other retail categories, the signs are ominous. In conjunction with AmazonFresh, this has inevitably increased competition and customer expectations. As a result, traditional supply-chain models have been challenged and companies have been forced to rethink their logistics operations to meet the growing demand. This has fuelled increased investment in technology and infrastructure to enable logistics providers to compete in an increasingly digital world.
From an investment perspective, identifying the threats posed by technology change is crucial to properly understanding the risk profiles of portfolios and to preserving shareholder value over the long term.
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DISRU PTIVE TECH NOLOGY
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UK ONLINE GROCERY PENETRATION HAS GROWN WITH TECHNOLOGY BREAKTHROUGHS 8% 7% 6% 5% 4% 3% 2% 1% 0% 2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
SOURCE: C8 RESEARCH VERDICT RETAIL
PHARMA BREAKTHROUGH Growth in the pharmaceutical industry has historically been marked by major breakthroughs in research and development (R&D) of drugs. However, increasing global competition and patent expirations have squeezed margins in generic drugs. In response, regulatory and commercial incentives have encouraged investments into ‘orphan’ drugs that are used to treat rare diseases. With approximately 7,000 rare diseases globally with only 10% having treatments, pharmaceutical companies that are engaged in the R&D of orphan drugs may offer an exciting opportunity for investors who are looking for long-term growth in this sector.
At LGIM, we are pleased to offer diversified exposure to each of these investment opportunities via our range of Disruptive Technology ETFs. In many instances, these are the first European ETFs of their kind, tracking the growth of these rapidly evolving investment themes. To learn more about L&G ETFs and our latest thinking to help you make more informed investment decisions, visit www.lgimetf.com
DIVERSIFICATION IS THE KEY For investors looking to gain exposure to these trends, there are some important considerations. It is often hard to predict where the next major disruption will come from, as many of these opportunities are still in their infancy. Investors can be blindsided by technology risks, from smaller disruptors or from other industries, and even well-understood technologies can have unexpected impacts. Understandably, markets sometimes initially misprice these risks and the eventual correction in asset values can be extreme. From an investment perspective, identifying the threats posed by technology change is crucial to properly understanding the risk profiles of portfolios and to preserving shareholder value over the long term. Investors should therefore be aware that growth may be volatile and is not guaranteed. Furthermore, there is likely to be a need to have broad exposure across your chosen theme.
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The case for employing embedded currency hedging in ETFs A transparent hedging strategy can reduce currency risk and optimize portfolio return. That’s the view of Andrew Walsh, Head of Passive & ETF Specialist Sales - UK and Ireland at UBS Asset Management
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nvestors in international equity ETFs are exposed to two main risks: the direction of the equity market in which they have chosen to invest; and the foreign currency exposure that is often a by-product of an equity bet, but which has the potential to derail returns. Without any currency hedging in place at all, investors are taking an implicit bet on the foreign currency strengthening, which may or may not be consistent with their macroeconomic view. It is a generally accepted view that currency risks exist primarily in the short to medium term, but less so in the longer term. That is to say, over the long term currency movements do not tend to add or subtract from investment returns as they usually average themselves out. In the short run, currency movements can be quite dramatic and can have a major impact on the returns of the underlying investment. THE IMPACT OF CURRENCY MOVEMENTS ON RETURNS To illustrate the extent to which currency movements can impact returns, one can go back five years to the Japanese market. A local Japanese investor holding the Nikkei 225 from 1st January 2012 to 30th June 2013 would have achieved a 66.9% return in Yen terms, while a US investor through that same period would have experienced considerably less impressive returns of 29.3% due to the steep depreciation of the Yen through that period. (Source: Bloomberg) Of course predicting currency movements is notoriously difficult and with concerns about currency volatility increasingly on investors' minds, many want to neutralise this uncertainty on investment returns so as to access the underlying investment as cleanly as possible.
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THE USE OF HEDGING Currency hedging could be compared to buying insurance. Simply, when an investor buys a fund with a currency hedge embedded in the product, they are trying to protect themselves from potential losses which would occur if the underlying currency of that foreign exposed fund (e.g., JPY, CAD, USD) were to decline against the GBP while the UKbased investor held the fund. Large institutions have little difficulty in accessing the foreign exchange market and thus can chose to implement currency hedging overlays across their entire portfolio. Unfortunately, this is not often possible for some mid-sized and the great majority of smaller investors in part due to a lack of solutions on offer to them. Thus, there has been an increasing demand from UK and foreign investors alike to access key international equity markets with currency hedging built into funds such as ETFs. An important aspect to consider when looking at currency hedged products is whether they follow daily or monthly hedging. From a conceptual point of view, monthly hedging features a less 'perfect' currency hedge compared to daily hedging. Implicit in monthly hedging is a higher risk of under- and/or over-hedging because of the longer time period between the nominal adjustments of the hedge. However, in practice, a higher frequency of hedge adjustments results in higher trading costs due to more transactions i) for adjustments of the hedging derivatives and ii) for investments and divestments of hedging profits and/or losses, respectively. In brief, daily hedged products on plain vanilla benchmarks tend to track their respective index more accurately (when not considering trading costs of the underlyings).
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However, in practice, when taking the trading costs into account, products using monthly currency-hedging benchmarks can more accurately track the index due to significantly lower trading costs. This is the reason why the ETF industry leaders tend to set up their physicallyreplicated UCITS ETFs on monthly hedged benchmarks. Furthermore, as currency hedging has also become an important feature for passively-managed portfolios, a key criterion for index providers is to establish a methodology which allows replication of hedged benchmarks as closely as possible. Hence, it is not only relevant at which point in time a profit is reinvested, but also the timing of putting in place a new currency forward agreement. We expect index providers to continue to improve their currency hedged methodologies to account for these points. This will ensure excellent tracking quality of the products, while minimizing tracking error compared to the underlying benchmark. Another good example of a case for currency hedging slightly closer to home is that of the Eurozone equities market over the 2yr period between May 2013 – May 2015 (SEE CHART 1). Through this period, the MSCI European Monetary Union (EMU) index delivered +19.6% annualized returns for a EUR investor. However, a UK-based investor buying the same index (without any GBP-hedging) would have experienced an annualized return of just +11.7% due to the negative impact of the decreasing value of the Euro against Sterling during this period. If the UK-based investor had instead opted for the MSCI EMU GBP-hedged index through that period, their returns would have been almost identical to the Eurozone investor at +19.9% per annum (in this case, slightly better performance than the unhedged local currency returns due to the way the monthly hedging panned out through this period).
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neutralise that impact and participate in this exposure just like a domestic US investor. Ultimately, investors will have an increasing choice of funds which offer currency hedging – particularly with ETFs. Where investors want exposure to a particular country or region's equity or bond market without the risk of having to take any specific conviction on the direction of the currency, a currency hedged ETF offers very easy and cost-efficient access to international market indices. Finally, investors should be aware that if a fund has a GBP listing, that does not make it GBP-hedged. Only a product which is actually currency-hedged can protect an investor from a declining foreign investment currency. An important caveat for investors to be aware of is that currency-hedging is a double-edged sword. That is to say, if a foreign currency appreciates against Sterling whilst you are invested in a GBP-hedged product, you will forego the gains that that appreciation would have delivered. Thus, for investors who feel that that the currency of a specific country (Japan) or region (Eurozone) is likely to rise in future would typically want to avoid buying a fund exposed to them with embedded GBP-hedging. UBS Asset Management is Europe's 5th largest ETF provider with GBP 34bn in AUMs and is a one of the leading providers of currency-hedged ETFs in the region. UBS has a wide range of ETFs available for UK investors with 101 LSE listings across key asset classes.
CURRENCY HEDGING IN FIXED INCOME While there is far more prevalence for using embedded currency hedging in equity ETFs, it is in fact arguably, an even more important consideration when investing in foreign fixed income. This is due to the fact that currency movements can, in many cases, easily outweigh returns from both a bond's coupon and price returns. This means that an investor's returns in foreign fixed income are sometimes totally at the mercy of these currency fluctuations. CHART 2 shows the example of the Bloomberg Barclays US Liquid Corporates index return makeup in USD (see chart 2 – simply price return and coupon) for a local US investor. CHART 3 shows this index for a UK-based investor who must bear the currency swings of sterling vs the dollar while investing in this index. As is clear from the red bars, the UK investor's returns overall are more often than not dictated by fluctuations in the GBP/USD rate, not the price return and coupon. An investor choosing this index (and an ETF tracking that index) with embedded GBP-hedging would be able to
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Andrew Walsh is Head of UBS Passive & ETFs
Specialist sales for UK & Ireland and is responsible for developing and implementing the UBS ETF business in the UK. Andrew joined UBS Asset Management in November 2012 and has 24 years of investment experience having worked at Societe Generale and HSBC prior to joining UBS. Andrew holds the Investment Management Certificate (IMC).
andrew.walsh@ubs.com
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CHART 1 - LOCAL CURRENCY FIXED INCOME (VALUATION CHANGE + ACCRUED INTEREST)*
CHART 2 - BARCLAYS US LIQUID CORPORATES (USD, LOCAL CURRENCY) *
CHART 3 - FOREIGN FIXED INCOME (VALUATION CHANGE + ACCRUED INTEREST + CURRENCY P&L)*
*SOURCE: BARCLAYS POINT, UBS GLOBAL ASSET MANAGEMENT. DATA AS OF 31 AUGUST 2017.
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ETF round table
ETFs: the solution to the retirement advice gap? Advisers are looking to ETFs to help clients build retirement savings and ETFs are adapting to help solve this pressing issue
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he simplicity and low-cost nature of ETFs are helping to fill the advice gap and ensure more investors build sufficient funds for retirement. Pensions are no longer seen as sufficient to fund increasingly long retirements and advisers are having to look elsewhere to ensure clients have enough put away in long-term savings. Howie Li, Head of ETFs at Legal & General Investment Management (LGIM), says wealth management firms are providing clients with scalable retirement solutions and increasingly using ETFs that can address the advice gap. ‘ETFs are the building blocks for asset allocators,’ he says. 'ETFs can help fill the advice gap'. He says that some businesses can provide advice ‘for less than 1%’ as ‘they’re providing a digital interface can interpret a client's objectives and risk appetite to then come up with a solution within a range of portfolios made up of ETFs.' ‘Digital rob-advice is a slow-growing area but it addresses the advice gap as it's designed to be scalable and electronic,’ he says. ‘With the increased in use of technology and how we consume things, people will do it on their phones, laptops and tablets. It’s interesting to see traditional models try to evolve. I was speaking to a wealth management company which is trying to transition, they say the feedback from investors has been that they want to be provided with lower cost solutions and they’ve heard that ETFs are efficient. They’re transitioning the business model in response to
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customers. That’s driving the business to become more digital and as the scalability increases, it will help address the advice gap.’ SAVVY INVESTORS The popularity of ETFs for retirement investing - and investing generally - has grown as investors’ understanding of their finances has also grown. ‘I think investors are savvier than they were a long time ago,’ says Jeannette Cottrell, a Chartered Wealth Manager at Tilney Investment Management. ‘Theme-driven investing is big now. ETFs should be the basis for easy access to a specific market, there’s a place for ETFs in thematic investing [as] managers can bring out products quickly.’ Christine Cantrell, Director of ETF sales at BMO Global Asset Management, agrees that product providers are turning around funds much more quickly and there is ‘more innovation and new concepts being launched in ETF wrappers’. ‘There’s more focus and investment in providing these solutions,’ she says. ‘I believe it’s because of the economies of scale, and the ETF gets to be more efficient as you’re outsourcing some of the cashflow management to the exchange. You can focus on strategy, you can bring out something quite quickly.’ This innovation will continue as investors increasingly use ETFs for long-term allocation plays. ‘ETFs will continue to bring innovative solutions,’ says
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ETF round table
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Li. ‘We see many investors who use them for long-term strategic asset allocation. An ETF is interchangeable with a traditional unlisted mutual fund.’
exchange-traded so you can see real price transparency’ and managed to track an investment strategy.'
LIFTING THE LID
Although the history of ETFs is shorter than that of active mutual funds, Li says their strategies are ‘maturing and we’re seeing developments, where techniques previously employed by discretionary fund managers for specific outcomes are being deployed into an index in a transparent mannerfor consistency.'
Li adds that what is exciting about long term thematic investing using ETFs is that they are ‘not just trying to give exposure to the largest companies within an index but instead they can provide instead they can provide exposure to non-traditional themes. We’ve got a robotics fund, a cybersecurity fund and e-commerce for example. These don't sound traditional as they are about identifying long term themes that are taking place because how we live is changing and a shift is happening,’ he says. ‘The key is identifying the companies involved in the change, which companies are developing the tech, and which companies are integrating this kind of thinking into their business.’ In order to identify the companies that will benefit most from thematic change, LGIM works with ‘dedicated experts in those areas’ to identify the companies driving the change and understand 'how the theme is changing how we live and work.'
Pensions are no longer seen as sufficient to fund increasingly long retirements and advisers are having to look elsewhere to ensure clients have enough put away in long-term savings.
‘We spend a lot of time researching these companies...the data is hugely relevant to developing a unique investment strategy as well as identifying the companies that are key,’ says Li. Li maintains that ETFs are no different from mutual funds as ‘ETFs are a wrapper’, they just ‘happen to be
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ETF round table
ETFs guiding the way on objective-led investing As advisers focus on their clients’ objectives, the ease, price, and transparency of ETFs are helping them build new investment strategies
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ost-conscious clients are increasingly driving the direction of advisers’ investment strategies towards ETFs and a greater focus on ‘objective-led’ investing. Fees have been of paramount importance to the regulator and to clients, who want returns at a fair, and low, price. While the virtues of active fund management are well known, advisers often want to minimise the time they spend on fund research and due diligence when researching the ins and outs of every fund. Clients too are keen to hear how they might invest in markets that they may not otherwise have had exposure to. This is where ETFs are coming into their own as they are offering greater diversity of investment choice and at a decent price. Howie Li, Head of ETFs at Legal & General Investment Management (LGIM), says fee pressure is ‘felt across the board’. ‘It’s about recognising that this is what investors want, they want lower cost investing,’ he says. He adds that ETFs, passive funds, and active funds are all investment tools that provide advisers with a very wide choice – a spectrum of knowledge and research to fuel their asset allocation decisions. ETFs are ‘attractive’ for providing low-cost asset allocation solutions that reflect the movement of the underlying market. Advisers are using ETFs ‘flexibly’ and ‘interchangeably’ and as a ‘flexible investment tool’, says Li. Tony Catt, Compliance Officer at TC Compliance Services, says ETFs often allow advisers to ‘go into markets they wouldn’t research themselves’. ‘Advisers increasingly look to outsource the management of clients’ investments. It’s useful having those funds going into various approaches as ultimately they’re looking for a diversified portfolio. More and more advisers are considering – and using - the passive approach, mainly driven by costs, but it’s also a consistency of performance that appeals too.’
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He adds that whilst active managers ‘can produce great things but can also underperform significantly, the ETF will tootle along with the market’. ‘There’s consistency and reassurance that you won’t be miles away from what’s being quoted in the market,’ says Catt. While ETFs have undeniably shaken-up the investment landscape, Christine Cantrell, Director of ETF sales at BMO Global Asset Management, says that more change is around the corner. OBJECTIVE-LED PORTFOLIOS ‘I think the evolution to come is on the growing emphasis of objective-led portfolios,’ she says. ‘This comes back to the wealth managers constructing the portfolios, on the basis of what is the end-client’s objective.’ Testament to the concept of the ‘objective-led’ portfolio is the 33% rise in non-market-capped weighted indices, says Cantrell, showing that factor-based indices are growing as ‘they’re delivering on objectives’. ‘Advisers can still choose active managers for small parts of their clients’ portfolios when they’re delivering specific needs but they will want to keep them at a minimum if they’re looking to control costs and for the rest of their portfolios, turn to low-cost solutions,' she adds. She says BMO has focused on objectives with an income-focused range that took into account ‘the criteria an active manager would look at in stocks for income’. ‘You can construct a sensible approach even if on a day-to-day basis it’s not being managed by a human, although a human put the rules and criteria in to deliver on a certain objective,’ says Cantrell. While cost is a factor, for Catt, the appeal of ETFs is the more understandable labelling of the funds which provides ‘more confidence about choosing it and not having an
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ETF round table
overlap with another’. He believes this enables advisers to build a stronger portfolio ‘as you understand what’s under the bonnet’. ‘It makes it easier from a compliance point of view,’ he says. ‘If you’re looking at a portfolio that’s meant to generate income or is aiming for growth, you can see where the risk rating is going to be as you can see quite accurately what you’re buying. To me, ETFs have an advantage as I think they would be more buy-and-hold focused rather than carrying out lots of transactions to maintain their closeness to the index, so that cuts down the cost.’ However, not everyone is completely committed to ETFs and Jeannette Cottrell, a Chartered Wealth Manager at Tilney Investment Management, says she uses ETFs in ‘specific markets’. ‘My firm belief is in adding value for clients so we use mutual funds that are active manager-led,’ she says. ‘The majority of funds we look at are actively managed. We see ETFs as a growing market, especially now that clients are more cost conscious, but it doesn’t make up the majority of our business.’ THE SHIFTING LANDSCAPE OF ADVICE
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WHAT ABOUT PLATFORMS? Investment platforms are seeing the need to expand their universe to include ETFs even though the take-up may have been a bit later than anticipated. Cantrell says that in the UK ‘everyone expected the use of ETFs to take off after the retail distribution review (RDR)’ but it is now ‘obvious’ that the ‘main hurdle was with platforms as they were mainly structured to deal with mutual funds’. ‘Now more platforms are tech savvy’ she says, and giving a level playing field to access ETFs. ‘This is a huge turning point across the UK.’ There has been a huge shake-up in the way funds are structured, to the use of technology, and of investment costs. All these have combined to ensure ETFs are much more in advisers’ – and investors’ minds. Cantrell says there has been a change in the ‘structure’ around funds and technology that has provided greater access and transparency. ‘ETFs take many of the characteristics of regular diversified funds and are making them more accessible.’
The growth in online advice is changing the landscape of investing and fuelling the popularity of ETFs. Li says there are investors who have ‘disposable income’ that they want to invest but do not meet the minimum requirements, or do not want to pay for, a bespoke financial planning or wealth management service. ‘Digital solutions offer low-cost management of money,’ he says, adding that wealth managers are looking at different options to ‘provide efficient ways to allocate assets’. ‘What’s interesting is what these funds are using for asset allocation are often ETFs. That’s to do with it being data driven - you can make a real-time transaction,’ said Li.
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There has been a huge shake-up in the way funds are structured, to the use of technology, and of investment costs. All these have combined to ensure ETFs are much more in advisers’ – and investors’ minds.
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ETF round table
The second change is around cost, and while Cantrell says there has been a ‘lot of fear-mongering’ on the active versus passive debate, the main question is ‘will it benefit the end investor if the costs are reduced?’
On a side matter, he adds that MiFID II is actually bringing European advisers up to the levels of those in the UK, where we have ‘always had KIID documents’ and so in this respect the impact on advisers here has been less.
‘If you can access a lot of new strategies or get more efficient access to different asset classes, that can benefit the investor,’ she says.
‘We had the RDR in 2013 and that was our MiFID II really,’ says Catt. ‘ETFs are well-placed to be part of everyone’s strategy in the future because of the transparency they provide which is right in line with what the regulators are looking for.’
‘We’ve done a lot of studies and had communications with IFAs to help steer our product development across the board. We have noticed a huge uptake in using a passive approach as the underlying model, but when we probed further and asked IFAs why they were tending to choose those models, it was down to cost.’ Increased automation and the subsequent use of ETFs to build asset allocation models will help advisers to focus on delivering more ‘objective-led’ advice. ‘What IFAs have been good at building is strong client relationships where they clearly understand their client’s goals. This extends to discussing with clients how these solutions can help to send the kids to university or be mortgage-free,’ says Li. WHAT ABOUT THE REGULATOR? The strong focus on meeting clients’ objectives is also a key driver for the Financial Conduct Authority (FCA). Catt says the ‘FCA is very much focused on client outcomes, with that comes ensuring the comfort of the client to knowing what they’re investing in and why’. ‘The onus is on the adviser to find out what the client’s objectives are and then to build an appropriate portfolio to maximise the potential of achieving those objectives,’ he says. ‘The fact that ETFs make it clear about what you’re buying and the charging structures being more transparent are positive things for the regulator.’
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ETFs also tick another box for the regulator, which has become increasingly cost conscious when it comes to fund selection. Cantrell says a 2017 FCA market study was about ‘value for money in terms of how much [funds] cost’ that ‘really honed in on the compounding effect of high underlying investment fees’. She says the study ‘ousted a lot of closet trackers’, ie active funds which hug a particular index tightly meaning managers are effectively operating a passive strategy but with an active price tag. As ever, with regulation it is a balancing act between enabling businesses to function effectively and also providing clients with a value for money investment service. ‘There’s a big balancing act as far as the FCA and active managers are concerned,’ says Catt. ‘The FCA wants to see that advisers operate profitably so they continue in the profession. It can be quite a difficult balancing act to achieve value for the client as well as ensuring profitability throughout the chain of advice so that the firm can remain profitable and therefore maintain its ongoing service to its clients for the long term. After all, this is where the real value of a transformational financial planning service happens for clients. Helping advisers to deliver effective, transparent and low cost portfolios for the long term can only boost the chances of this happening.
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ETF round table
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THE QUIET RISE OF ETFS Investment experts argue that ETFs aren’t flavour of the month, they’re a fundamental part of a client’s investment portfolio
H
uge flows of money into ETFs have proved the ever-growing popularity of the investment vehicle, but also led to worries about them becoming ‘flavour of the month’ investments.
Over just five years, the amount of money invested globally via ETFs has more than doubled. According to figures from data provider ETFGI, in July 2013 a monthly record of $44 billion was invested into ETFs and exchange traded products (ETP), taking total investment to $2.16 trillion. In July last year, a new record was set as total ETF and ETP assets under management tipped $5.12 trillion. A report by EY predicted that assets in ETFs globally could reach $7.6 trillion by 2020, fuelled by digital platforms, low yields on investments, and the move towards self-investing. THE FIGHT AGAINST FEES It is undeniable that investment into index-tracking funds has also been fuelled by a growing discontentment with high active fund fees and lack of consistent performance from active managers but has the pendulum swung too far the other way? John Barrass, Deputy Chief Executive of the Personal Investment Management and Financial Advice Association (PIMFA), questions whether or not the huge amount of money going into ETFs is an issue. ‘Is there a risk that ETFs have become too much of a flavour of the month, and how have professional advisers and their teams been taking account of that potential concern?’ he asks. However, far from offering up a ‘flavour of the month’ investment, advisers recommending clients to invest in ETFs are aiming to provide them with an opportunity to better understand their investments.
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INCREASED TRANSPARENCY Christine Cantrell, Director of ETF sales at BMO Global Asset Management, says: 'ETFs have a new advantage over active managers in regards to the MIFID II requirement of 10% depreciation reporting within the same business day. At least with ETF holdings, an adviser can clearly look at how the ETF has performed and what has caused that.' She says this is ‘different to active managers as they can drift away from their task because they can, then it’s less transparent for the advisers to tell their client what happened and why’. Cantrell says that while ETFs are undeniably popular, and becoming increasingly so, there should not be any concern about the way they are shaping markets. ‘ETFs are only a small part of the overall investable market,’ she says. ‘An area that’s even more misconceived is fixed income; they’ve always dealt over-the-counter not on a transparent exchange, but fixed income ETFs bring more transparency to that investment class.’ Cantrell says advisers have ‘utilised’ ETFs in volatile markets over the past decade. It is possible they will get to utilise them more if the predicted economic slowdown and subsequent return to a bear market after a decade of growth happens. ‘The beauty of an ETF is that the price is live and you can compare it to the underlying holdings; evidence shows that the difference between the ETF price and NAV has stayed very much consistent, very close to zero, even during volatile periods,' she says. ‘Volumes of ETFs traded have really increased during those volatile periods, and this encourages more players into the field who are increasing competition and price discovery. People have had bad experiences with some active high
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Februar y 2019
ETF round table
yield funds in the US and during the Brexit referendum aftermath there were closures in certain property funds, so to be able to have a structure of a vehicle that's constantly accessible, that's very appealing.' A FORCE FOR GOOD Howie Li, Head of ETFs at Legal & General Investment Management (LGIM), does not believe ETFs are just flavour of the month investments but a part of the range of good index investments which can help mitigate risk and provide diversification for clients. ‘What’s been clear in the last five years is that more money is moving towards index investing,’ he says. ‘ What that means is with more money flowing in tracking major benchmarks, you have this portfolio turnover where everyone is buying and selling stocks around the same time...There’s more demand for a short period so that causes a short price volatility.’ He admits that this is a problem for ETF investors but he believes LGIM has identified a solution which helps to mitigate the risks. ‘We have a new fund range that gives you core exposure to the largest companies in a particular country but we're avoiding the crowds that are trading the underlying stocks. We're moving the rebalancing periods to mitigate opportunistic activity that comes with more money tracking indices. Why do we all buy and sell at the same time?' He adds that LGIM also looked ‘at identifying risks in certain companies’ and mitigate those through mild exclusions and using voting rights and shareholder power to be a force for good in markets.'
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‘You can construct investment strategy where you can anticipate risks and mitigate them. 'For stocks that we hold, we can use our voting power in companies owned by the ETF to say that we don't like their approach on things like executive pay or corporate governance,' he says. ‘If index investments are run well, this active voting power and engagement with companies can help preserve the value of passive investments'. The huge inflows into ETFs have encouraged swathes of new launches and advisers are under pressure to keep on top of the different investment options available to clients. Research is imperative to an adviser’s (and paraplanner’s) job and just like doing due diligence on active funds, advisers will have to employ a similar level of due diligence here. Jeannette Cottrell, a Chartered Wealth Manager at Tilney Investment Management, says she works alongside a ‘dedicated research desk’ which is ‘quite relative to our peers’. ‘They put together an approved list for what we can buy, which includes ETFs,’ she says. ‘Really, we’re working off that particular list. If there’s something not on the list but we’d like it, we’d approach [the research desk] and they’d do the underlying research.’ This is a contrast to the company Cottrell worked in before Tilney, where ‘you’d go out and see what was available, you’d look at Morningstar, do a universe search, and you make your choice.’ ‘You’d typically go for the larger names used before... It wouldn’t be based on cost, it would be based on how specific it was to the objective we had,’ she says. ‘We’re not just looking for exposure to a market, we’re looking for a specific theme or objective.’
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ETF round table
DOMICILE She adds, however, that one problem that advisers face in the expanding universe of ETFs is the domicile. ‘One of the confusions I’ve had is that a lot of ETFs are domiciled in different places and this has tax implications,’ says Cottrell. ‘It’s not clear to investors what the tax implications are. People don’t know and the risk warnings aren’t clear enough.’
Februar y 2019
with ETFs then they’re not doing their job but it’s almost the opposite,’ she says. ‘You’re thinking about [whether] the objectives have been achieved and you’ve selected more value-add solutions to the client, that’s what you should be judged on. It can be much easier because there’s more data available; ETFs have to make everything transparent.’ She adds that ETFs make adviser research easier when it comes to calculating costs for clients.
DUE DILIGENCE Li says that ETF due diligence is the same for any fund but some advisers are looking for research that helps them to make asset allocation decisions. However, he notes that wealth managers and discretionary fund managers have more tools at their disposal when it comes to research but ‘if you’re an individual IFA, sometimes these tools aren’t available as you might be looking at a paid subscription service that individuals might find difficult’. ‘[IFAs want to see] if the ETF or mutual fund is delivering, how closely is it tracking the index and what are [the] fees?’ says Li. ‘You’re seeing more and more businesses that are able to explain to investors which (funds) are doing the best job of tracking the market or keeping fees low. I expect this to continue to grow to help educate the retail side of the market.’
ETFs make adviser research easier when it comes to calculating costs for clients.
‘It’s easier to quantify the total cost of ownership with ETFs,’ she says. ‘There’s a lot of research that goes into the selection of different ETFs. When you come to some ETFs with similar objectives, or if they’re in a similar category, you can see diverging performances or volatility. The more they evolve, the more apparent the value-add that’s being delivered.’
Advisers relying heavily on ETFs for client portfolios could come under fire for failing to add value in the same way an adviser picking active funds is but Cantrell disputes this. ‘On the research side, maybe in the past people would have thought if their adviser is filling their [clients’] portfolios
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Sponsored Feature Invesco
USING ETFS TO POSITION FOR A
US VS CHINA TRADE WAR
Many media and market commentators believe that the ongoing US-China trade war could be one of the largest risks facing the global economy. Invesco analyses the situation and highlights how advisers and wealth managers can use ETFs for efficient asset allocation within clients' portfolios
W
hile the degree to which relations deteriorate is unknown, many advisers are understandably exploring how best to position their clients’ portfolios amidst the potential economic impacts. In this article we explore the sectors and asset classes likely to benefit and suffer across a range of trade tension scenarios, why exchange-traded-funds (ETFs) are a useful tool for implementing the sort of nuanced investment exposures that are required for such scenarios, and how an adviser might implement these targeted views. Let’s first consider why ETFs may be an ideal vehicle of choice to express nuanced investment views. ADVANTAGES OF ETF S FOR TARGETED VIEWS
ETFs are unique in many ways. One unique feature is the granularity of exposure many ETFs offer. As most ETF assets are held in broad index trackers, many are unaware of the rich offering that exists in more narrowly-focused funds. These ETFs can be used as “satellite” investments around investors’ core exposures to help fine tune portfolios to specific market or economic investment views. Take sector-specific ETFs for example. Due to these ETFs’ different sensitivities to macroeconomic factors, geopolitical shifts and other news flow, many asset allocators use sector over- and under-weights to position their portfolios according to their views. Why might an adviser use an ETF over an activelymanaged sector-specific fund? Sector-specific ETFs have several advantages over actively-managed funds. First, ETFs provide easy access to a full range of sector exposures, and many passively track indices at lower costs. When compared to achieving the same exposure via an active
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manager, an ETF may help reduce the need for lengthy due diligence across many different managers. Many sector specific active fund managers are boutique firms that lack a full range of sector funds, and so those investing in these active funds may expend more time and resources performing due diligence. By using passive replication, ETFs act as tools for pure directional positioning. This may mean less or no unintended conflict between the sector ETF exposure and the positioning or view of the end investor—many activelymanaged sector funds are run as a long/short strategy to increase the opportunity for outperformance, but therefore provide less pure directional exposure. Another advantage of sector ETFs is breadth of choice. For example, the most actively-traded sector range in the US offers 11 different funds, and, in Europe, there are 18 funds in the most popular sector family. There is also a wide range of ETFs that track less traditional sectors (for example, fintech, robotics, even water) and more thematic indices (for example, exporters and importers). Lastly, ETFs offer benefits because of how they trade. Sector views tend to be more tactical and short-term than broader regional or asset allocation decisions. By using ETFs within portfolios, it is easier to respond to news quickly, even intraday, and have no mandatory holding periods or pre-defined redemption windows. ETFs are designed to accommodate this type of high turnover trading. Whether it’s easy access through less due diligence, pure directional positioning, choice or trading, for advisers and clients seeking nuanced investment exposure, granular ETFs, such as sector ETFs, may be the preferred investment vehicle.
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Sponsored Feature Invesco
POSSIBLE SCENARIOS AND POSITIONING FOR A US-CHINA TRADE WAR The ongoing US-China trade tensions provide a convenient framework for examining how portfolios can be adjusted in line with opinions and views. We identified a scale of scenarios: • Full-scale trade war that also negatively impacts other countries outside the US and China • No all-out trade war, but a selective application of tariffs to a limited number of products • China and the US both stand down without any repercussions. We believe the most likely scenario is not an all-out trade war, but a selective application of tariffs to a limited number of products. This would likely drag on global economic growth and push inflation up in the US as higher imported costs are passed on to consumers. Under this scenario, we expect domestic companies would fare better than exporters. Defensive sectors such as consumer staples, utilities, or healthcare, would likely outperform cyclicals such as banks or technology. For advisers looking to invest directly into China as a component part of their clients’ portfolios, we believe the impact of selective tariffs on the overall Chinese economy would likely be moderate. Some may view the broad sell-off in Chinese equities during 2018 as representing a fair assessment of this impact, or alternatively as an overreaction and therefore an attractive opportunity to invest. However, when considering investment in China, it is necessary to select an index. There are several widelyrecognised broad Chinese benchmark indices available through ETFs to choose from. In general, the more concentrated indices, such as the FTSE China A-50 (A-shares), have a higher exposure to more mature, “traditional economy” stocks – in particular financials. These companies are likely to have closer ties with the central government and exhibit more stability and less volatility than many of the smaller companies that are found in broader index benchmarks, such as the MSCI China or CSI-300. The other two scenarios we identified are the extrema. The worst-case scenario is a full-scale trade war that would negatively impact other countries. This could lead to a global recession which would be particularly damaging for commodities, equities, and emerging markets. At an asset class level, we believe the relative winners are likely to be “safe haven” asset classes such as gold, Treasury bonds, and cash. In terms of equity exposure, the worst-case scenario would favour domestically-focussed defensive stocks. Sectors such as health care, utilities, telecoms, and consumer staples would likely hold up much better than cyclicals. China A-shares in this case would be expected to underperform, in particular the more export-focused
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Februar y 2019
industrial and technology sectors would suffer. At the other end of the spectrum, there is the extreme outcome of a happy ending in which both China and the US stand down without any repercussions. If this were the case, we believe it would be a relief for global equity markets in general, especially for China. Chinese equities would benefit, and the broad sell-off in Chinese equities during 2018 could represent an attractive entry point we believe. Highly cyclical sectors such as basic resources and those most hurt by rising inflation, such as utilities, could be among those that benefit most. What stands out is that it’s likely the winners and losers would be sharply divided across the scenarios, based on whether they are exporters versus domestically-focused, cyclical versus defensive, and more versus less inflation sensitive. For investors following the markets, new information comes quickly and can have a significant impact on relative sector performance. ETFs provide a ready toolkit with which to easily realign portfolio exposures – whether to increase exposure to target sectors or reduce exposure to potential underperformers. The granular nature, wide offerings, and flexible trading characteristics of ETFs allow investors to be nimble, especially in preparation for today’s bourgeoning US-China trade war. INVESTMENT RISKS Investment strategies involve numerous risks. Investors should note that the price of your investment may go down as well as up. As a result you may not get back the amount of capital you invest. Important information This document contains information that is for discussion purposes only, and is intended only for professional investors in the UK and Qualified Clients in Israel. Information correct as at December 2018, unless otherwise stated. This document is marketing material and is not intended as a recommendation to buy or sell any particular asset class, security or strategy. Regulatory requirements that require impartiality of investment/investment strategy recommendations are therefore not applicable nor are any prohibitions to trade before publication. Where individuals or the business have expressed opinions, they are based on current market conditions, they may differ from those of other investment professionals and are subject to change without notice. Issued by Invesco UK Services Limited and Invesco Asset Management Limited, both registered at Perpetual Park, Perpetual Park Drive, Henley-on-Thames, Oxfordshire, RG9 1HH, authorised and regulated by the Financial Conduct Authority. © 2019 Invesco. All rights reserved | EMEA264/2019
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