October 2019
ETF ROUND TABLE LONDON
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October 2019
PARTICIPANTS Howie Li
Samit Patel
Head of ETFs, Legal & General Investment Management
Financial Planner, The Fry Group
T: 0345 070 8684 E: fundsales@lgim.com W: lgimetf.com
T: 020 7592 1332
John Barrass (roundtable chair)
Zul Alladina
Deputy Chief Executive, Personal Investment Management & Financial Advice Association (PIMFA)
Head of Wealth UK, Goldstar Wealth
T: 020 7011 9862 E: JohnB@pimfa.co.uk A: 22 City Road, Finsbury Square, London, EC1Y 2AJ
T: 020 8684 1851 E: zul@goldstarins.co.uk A: 1E High Street, Purley, Surrey, CR8 2AF
Julian Barnard
Irene Bauer
Principal, Barnard Lee Associates
CIO, Twenty20 Investments
T: 0207 627 4791 / 07790021670 E: Julian@barnardlee.co.uk
Mike Mount
Tony Catt
Director Intermediary Solutions, JM Finn & Co
Freelance Compliance Consultant
T: 02920 558803 E: mike.mount@jmfinn.com
T: 07899 847338 E: info@tonycatt.co.uk
Neil Weston
Alex Sullivan
Director, IAS Financial Planning Ltd
Managing Partner, Clifton Media Lab
T: 01206 323854 E: n.a.weston@btinternet.com
T: 01173258328 E: alex.sullivan@ifamagazine.com
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A MATTER OF
CHOICE OEIC? Investment Company? Index fund? ETF? How do you decide which asset classes to use in order to gain appropriate exposure to a particular investment sector within a client’s portfolio?
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iven the increasing popularity of ETFs, roundtable chair John Barrass kicked off proceedings at the IFA Magazine ETF roundtable event held in London in June. He began by asking participants for their views on whether ETFs are taking over or simply becoming more mainstream when it comes to portfolio construction? The low cost of ETFs relative to other asset classes has traditionally been seen as a significant driver behind their growing popularity. Whilst the cost of index funds has been falling in recent years, there is still an increasing demand for ETFs. Alex Sullivan commented that “we are seeing a lot more interest and uptake in ETFs from our progressive readers.” When it comes to investment management Mike Mount stressed the need for detailed analysis and research across all sectors and asset classes including ETFs, commenting “You need to research the whole universe, you need to look at everything. Where we find ETFs particularly valuable is if you want to make a short-term return. The trading
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flexibility they provide allows you to do that. If you want short-term exposure, do you want to use an open-ended fund to get that exposure? It doesn’t cater to the short term. Whereas with the ETF, it’s quick exposure to the underlying sector, it’s a very flexible tool.” But are there complexities within the structures that advisers need help to understand? Neil Weston of IAS Financial Planning suspected that there were. He commented: “The mutual fund world is simpler and easier from our perspective”. Taking this concept of complexity forward a step, Howie Li of L&G ETF was interested to find out how participants see the layers of complexity in a FTSE 100 ETF as compared to those of a FTSE 100 tracker fund? Weston responded by explaining his thoughts in more detail: “There’s such a huge array of those vehicles that, from a research viewpoint, understanding what you’re getting and what’s involved is an added risk. It’s like with investment trusts, where there’s an added layer of complexity in terms of gearing the asset values.”
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INCREASED TRANSPARENCY Compliance consultant Tony Catt suggested that ETFs offer great clarity and transparency than other fund structures: he commented “ETFs are better badged than mutual funds because you can see what they’re trying to achieve, follow, and what it contains. If a particular ETF is geared towards technology, it will say. Using a managed fund, it’s not badged that way, so you wouldn’t know. ETFs are easier than the other funds to identify and use.” Of course, advisers and investment managers need to carry out effective due diligence on whichever fund or investment structures they are considering for use within clients’ portfolios and to weigh up the advantages and disadvantages. Howie Li took a step back with a personal take on the challenges which such research and analysis presents. “I have been on an ETF journey for well over 10 years,” he said. “We only see ETFs as delivery vehicle for an investment strategy. What we’ve seen over the past decade is a migration towards lower cost investments and passive investments. One reason why ETFs are getting more attention is the broader huge push towards passive investment – at Legal & General, we also have traditional index funds – and ETFs are just one more vehicle driving in that direction. Due diligence is still hugely important, of course. We can’t make the assumption that index funds don’t do stock lending or that ETFs only are synthetic, because you can structure an index fund and an ETF in the exact same way. They’re governed by the same rules and are both essentially traded as open-ended funds; it just so happens that ETFs offer a lot more transparency. So take a step back and look at how the fund is structured. You can easily structure a synthetic strategy in a traditional mutual fund and say that’s a normal OEIC. It’s not the ETF that
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adds risk; it’s the underlying strategy. The ETF wrapper may be an extra layer to explain, but ultimately what really matters is how, as an investor, you want to access that investment strategy.” MEETING CLIENTS’ NEEDS But do clients tend to have specific demands about investing in ETFs? The discussion made it quite clear that this wasn’t exactly an everyday occurrence. Many clients will simply not have sufficiently detailed knowledge about investment fund structures and options which is part of the reason they will have taken the step to seek professional advice - in order to obtain the most appropriate portfolio to meet their needs. Julian Barnard of Barnard Lee Associates commented “In terms of client demand for ETFs, I have a relatively high footfall of new clients coming through. The amount of times anybody has ever asked for an ETF, or even knows what it is, is about once. There probably is more demand where you’re dealing with high net worth clients, but not for the average client.” A final but salient point was added by Tony Catt who was going one step forward when considering adviser choices commenting “That’s where you prove your value as an adviser - that you know all about ETFs. Clearly, the adviser’s remit is to consider the full range of assets and where they might be most effectively employed within portfolio construction. However, ultimately the crucial element of suitability is driven by the needs of individual clients ensuring that the individual components meet cost, transparency and risk requirements.”
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WHERE AND WHY MIGHT ETFs BE USED IN CLIENT PORTFOLIOS? Alex Sullivan of IFA Magazine opened up this section of the discussion to find out where and why participants use ETFs as part of the asset allocation and investment decisions they make on behalf of clients.
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o help meet clients’ investment goals, advisers have a wide choice of sectors and fund structures at their disposal. This includes ETFs and the various different types of ETFs which exist. At J.M. Finn, Mike Mount began by confirming that ETFs are used as part of a client’s overall diversified portfolio. Given the nature of their business, Mount explained that J.M. Finn focuses very much on looking after the relationship with professional intermediaries as well as looking after the needs of the underlying client. The flexibility provided by the intra-day trading of ETFs is clearly an important factor. Julian Barnard of Barnard Lee also uses ETFs within his clients’ portfolios and gave an example of where he felt that they worked well, commenting “I might put in a volatility traded one to even it out a bit and keep costs down, so the bread and butter element of the portfolio is relatively cheap, and it’s the satellite elements you’re paying a bit more for.”
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RISK MANAGEMENT Managing risk and controlling volatility within portfolios is a crucial element for investment managers and advisers. This is especially true in today’s environment as the crisis at Woodford has highlighted the need for - and importance of – transparency as well as having pragmatic risk management controls in place. Once Howie Li of L&G ETF had opened up the discussion about risk, Mike Mount gave his view about comparing ETFs with active funds in this regard. He comments “I think it’s a bit of a myth that an ETF is riskier than active funds. I think it was the Bank for International Settlements who did a survey, and said that in times of volatility, it’s more likely to be active managers who are selling.” Julian Barnard of Barnard Lee had a slight counterpoint to that, reminding the participants that there are two different elements to risk. As he comments: “There’s the risk to the
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client, and the risk to me as an adviser. If I put my client in an index tracker fund or ETF, I’ve got to do more justification on the ETF. I’ve got more risk.” In such situations when risk is up for discussion, it was clearly just a matter of time before the subject of the ombudsman would emerge for consideration. This point was raised by Irene Bauer, Co-founder and CIO of Twenty20 investments. She asked for clarification about whether the extra level of justification was to the ombudsman or to the client and suggested that when it comes to the ombudsman, that they need education in this particular area. Julian Barnard was not going to dispute that commenting “I’m not saying it is reality, my perception is that I’m always going to justify an ETF more broadly than I am a tracker, because I feel there’s more inherent risk to me.” CLIENT SUITABILITY Samit Patel, a Financial Planner at The Fry Group SP outlined his firm’s approach which is to combine both active and passive funds in a core-satellite approach. He explained “We use advisory models and discretionary models. We use ETFs in the larger part of our portfolio, in areas such as the UK and Japanese markets. In satellite areas, we might use more active funds. For our advisory portfolio, we research all the funds and model portfolios, but we also pick and choose funds we put into client portfolios, so we do use ETFs there.” When it boils down to individual fund decisions, the client’s needs are clearly the key drivers in order to determine which solution is most appropriate to their needs, objectives and risk tolerance. Different client needs require different solutions. Zul Alladina is Head of Wealth UK at Goldstar Wealth. He was firmly of this view and commented to remind panellists that “everyone’s clients are different.” At Goldstar, we deal with a wide range of clients.. It’s very rare that they
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come in with a mandate stating that they specifically want ETFs.. What they’re looking for are solutions to a bigger problem, so they need the background story as to why they should be investing and how we create the solution to these problems. I don’t think they want to drill down into the details.” Alladina then brought up the matter of cost, stressing that “people are looking for value.” He went on to explain in more detail the firm’s approach commenting “how we build the value solution will include a number of different factors, actives, passives, ETFs. Our firm delivers multiasset solutions for clients and as part of this we are looking for long-term investment strategies. We’re not promising that our fund recommendations will be top performers, as long as it’s within a reasonable expectation and there is a reasonable benchmark set for the client. ETFs are important. If we consider the US market, ETFs account for a big take in terms of investment monies, but that's largely because of marketing differences. People do act also because of the 401k retirement plan situation which they have in the US. They have more knowledge. In the UK, knowledge is vastly lacking, and people don’t like paying for professional financial advice. As individuals, when we see that something is free, we react quicker to it than when there is the obstacle of a fee or cost to consider. When it comes to education, it’s not just about the ombudsman, but we can all benefit as discussed earlier.” In relation to Alladina’s point, Julian Barnard was keen to drill down into the specific nature of client portfolios in relation to that individual’s attitude to risk. He commented “You’ve got to explain to the client the risk and reward of any investment recommendation. They’re looking for returns yet if you offer them a mixture of core and satellite approaches with groupings of products which are passive and have active products around that, is that meeting client needs and expectations when they’re not very knowledgeable about investments. Obviously they can lose money as well as make it?”
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A LONG TERM APPROACH Alladina took it a step further again, with his view that a different set of risk principles apply, responding to Barnard’s point as follows “I think what’s missing is the time horizon. We tend to talk to clients about time horizons, which are 5-10 years plus. If they’re investing money, it should be money they won’t think about accessing unless it’s a last resort scenario. The capacity for loss bears heavily on the whole process and it's part of our due diligence that the adviser would apply that capacity for loss for that client. I agree with Howie, I don’t think risk is amplified when you employ an ETF, but you’ve got to put everything into context. If you put everything on red, you’ve got a 50:50 chance. As part of a diversified portfolio, I think that ETFs play a vital part as a diversifier.” Like all the panellists, Mike Mount was firmly of the view that client needs and requirements will be the driver of the investment process. As he commented “The investment return for the client over the long-term is going to come from the risk profile adopted. We’re not even talking about how we implement asset allocation at that point. How that is implemented, whether you’re building an advisory portfolio, is secondary to the client. It might be important from your perspective because you’re thinking, ‘How can I keep the costs down?’, because the client isn’t interested. It’s the asset allocation that matters, then implementation.” ATTITUDES ARE CHANGING
today, most multi-asset investors will look at ETFs and funds interchangeably. I think it’s about education. That’s our job, from an initiator’s perspective, to continue to provide that education to the market. In 5 years’ time – and it’s happening in the US - active ETFs will be coming into the market. It just so happens that you’re choosing the ETF wrapper. It might be because of the transparency, or because that’s where clients like to access it. We start to appreciate that it’s the asset allocation or underlying assets which really determine investment returns and the corresponding level of risk. Whether it’s an ETF or a traditional fund, it doesn’t matter. We should supply the investment strategy using the tool the client wants. I think that ETFs represent an improvement in technology that gives more transparency compared to an investment fund. People look at ETFs because they can see more detailed information and more data. It’s important for a lot of investment models that this transparency is there.” Whilst the discussion was generally very positive around the growing impact of ETFs within investment portfolios and the considerable value that they can bring, the conclusion that it is client needs and attitudes which drive the process will not come as any particular surprise to IFA Magazine readers. However, for this momentum towards the use of ETFs to continue, greater education and awareness is still needed, supported by the underlying organic development and growth in the range of ETFs which is already making such a positive difference to portfolio management.
When it comes to the implementation of investment strategies, things change over time. Howie Li gave some examples about how attitudes towards the use of ETFs have changed in recent years. “At LGIM, we believe we’re supplying tools for asset allocators. If we wind the clock back 5 or 6 years and look at how the market reacted to ETFs, they used to say they didn’t have a strategy, but now,
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SUSTAINABLE AND THEMATIC INVESTING USING ETFs How important is investing sustainably or getting access to thematic funds as part of your clients’ portfolios? In such cases, do ETFs provide an effective means of obtaining that exposure to these sectors? These are the questions which formed the basis of the final session at our roundtable discussion
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hen it comes to investment matters, it is inescapable that the relevance of sustainability and impact investing has become an increasingly important criteria for consideration by asset allocators and investment managers as well as financial planners. No longer are clients simply concerned about the performance of their investment portfolio or the risks that they need to take to achieve that return. It goes beyond that. As well as being appropriate for their needs and risk tolerance, an investment needs to sit comfortably with the client’s ethics, values and their moral compass. And the emphasis on this is set to grow significantly in the years to come. This was a theme which roundtable Chairman John Barrass was keen to discuss with the participants during this third session, asking whether sustainability was reflected in the ETF arena. It was certainly a theme which all participants were keen to pursue.
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Getting detailed information and analysis about products is an important element for professional advisers and this includes ETFs. Commenting on his experience in this regard, Neil Weston of IAS Financial Planning felt that more information would be welcomed commenting “We don’t get huge amounts of information or support from investment groups offering ETFs.” Clearly this would have implications of more responsibility and time considerations for advisers to carry out the necessary research into how they could achieve required exposure to particular sectors such as sustainable or thematic investing using ETFs. Howie Li, of L&G ETF, commented that in the drive towards sustainable investing, it is likely that clients will be more forthcoming; that they will say that they care about the environment and want their portfolio to be “greener”. He explained that “this is something that is a primary focus at L&G ETF. We think the future of investing will integrate a lot of these considerations because the next generation care.” In consequence, he pointed out that more investment managers are entering the ETF space and it was his view
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that investment in new asset classes or products such as sustainable or thematic areas are going to find themselves in the ETF structure. A key driver for him and his team is to understand exactly what it is that clients want to see and to deliver just that.
So, is adapting to change more difficult for an adviser in a small firm, where time and pressure on resources might be more of a constraint than it would be for a large DFM? That was the next question asked by Chairman, John Barrass.
He then went into more detail explaining that “Most of our clients don’t really care if it’s an ETF or a fund structure which is used. We spend most of our time explaining how we design investment strategies and taking active steps to redesign our investment strategies. We’ve got feedback that investors are saying they don’t want investments to include controversial weapons and coal mining, so we’ve started excluding some of those things.”
Alladina responded first and agreed that the roles are totally different. He commented “As a DFM, your remit is to generate returns and to find proper and appropriate investment strategies from the investment universe. Clients come to us not just for asset allocation, investment advice and a particular return on capital, they’re looking for a more holistic , overall financial planning solution and to build a relationship on faith and trust. It starts with a generic holistic view. If this is the asset allocation model based on what the client has today, we’ll start with a wider discussion around what they are trying to achieve and then we’ll be looking for the research tools and asking, ‘how do we build this solution?’ There are many different factors involved.”
TRANSPARENCY AND EMBRACING CHANGE In the light of the recent Woodford crisis, the consequences of which have had an impact on the wider investment sector, it has become clear that transparency is becoming increasingly important when it comes to investment selection. This is an area where ETFs have traditionally scored well. As Li explains “We reveal our holdings every single day. The expectation on the ETF market is that much higher. The regulator wants to step in and say, 'Is that riskier?' It’s amazing. I feel that over the last 10 years ETFs have got a much higher amount of scrutiny than traditional investment funds. People want transparency.” So what about the bigger picture? Zul Alladina of Goldstar Wealth. summarised it by saying “Change is what we’re talking about, changing people’s thinking, concepts, and ideas.” He went on to cite an analogy of the car industry and the move towards electric vehicles. “It’s new and different” he says, “I think the same thing is happening with strategies like ETFs. They’re another tool in a toolbox where there are many strategies. Change is coming, and it’s not going to stop. We have to embrace it, or we’ll become relics.”
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With his compliance hat on, Tony Catt made the point that the role and responsibilities of an adviser are wide. “There’s a client sitting in front of you, and once the plan is agreed you’ve then got to decide on which providers to recommend to get the appropriate products in place as part of the implementation process. Your time is precious. It leads us back to the education piece where you are more at ease advising on something you’re confident about. ETFs are tiny bit of that universe”. In this context there was consensus that it is important for all professional advisers to make sure they have all the information needed to properly consider all relevant alternatives and choices and that there is a strong case for ETF providers to up their game when it comes to providing such information to advisers.
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THE FINANCIAL PLANNING FOCUS The financial planning process was then brought into the spotlight. Mike Mount of J.M. Finn made an interesting point commenting “I think the reason that DFMs have taken up ETFs more is that we’re one step removed from the distributor. We might have close relationships with adviser firms and will be much closer to the manufacturing hub in terms of what’s coming out there. We’re not focused on financial planning, which takes up lot of time. As an example, in one mandate we run for a firm where a 15-page document is given to the client, we get one paragraph. That summarises it, it’s the financial planning piece that really matters for the client, how they can achieve their objectives and what return will they get to help them to get there. How it’s implemented is secondary.” Irene Bauer of Twenty20 Investments agreed. “To me, an ETF is just a fund, and it trades on an exchange. They’re much more transparent, especially in fixed income. Mutual funds, I don’t know what they do. They might change the duration and not even tell me. You don’t seem to have the control, whereas with ETFs they become more and more granular. I think that’s the beauty of it. They might not be cheaper than some mutual funds, but they’re not more expensive either. I don’t need anything else. We are a DFM, removed from the end client. Coming back to sustainability, I think that’s the one big thing that’s coming down the line. Is there still the perception that sustainability means accepting a lower return on average? I think that it was in the beginning, but I don’t think it’s true now. “ When it comes to the use of independent research, Alladina said that he and his firm use Defaqto. “For us, they deliver a well-rounded and balanced service which includes the investment market as well as protected solutions. It’s sufficiently in-depth, but everyone will have different needs and budget they’re working towards, and different understanding. What we sell is not products. Products are
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a tool, one of the various tools in our toolbox. But clients need to buy into you and what you can do for them, that's what I've always believed. If they don’t, they won’t buy anything from you.” WHAT ABOUT THEMATIC INVESTING? The development of precisely focused thematic ETFs allows investors and advisers to calibrate their asset-allocation process more finely, whether using themes for core growth exposure or for portfolio diversification. This is a particular strength at L&G ETF which is well known in the market for the approach of giving exposure to a particular investment or theme. So how do they go about it? Howie Li outlines the process commenting “First of all, we work with experts to understand, say for example, that we think that artificial intelligence (AI) will be a big driver for our society and over the next 10 years that this will change how we live. How do we invest in that? Then we try to access the database to find companies that are specifically positioned there. We’re selecting companies based on how they’re going to change for the future. Then we put that portfolio together, not trying to pick winners, and we package it and give a diversified broad exposure within the portfolio. It just so happens that this is within an ETF structure.” Julian Barnard of Barnard Lee found that point interesting on two fronts, commenting: “Increasingly, you look at it and the differentiation between an ETF and an open-ended fund is blurring. The demarcation between the two is becoming a Venn diagram. My perception is always that if you take an ETF, it’s effectively a driverless train, whereas a managed fund has a driver in it. I’d sooner have a driver in there, but Howie, you’re saying you can have an ETF with a driver in there? In the broadest context, if you want exposure to the S&P 500, then have an ETF. If you’re in the smaller company space, that’s where I want the driver.”
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Li responded “We want to give exposure to small-cap companies. Our job is to go through what’s underlying in each of these companies. Do they have sustainable income, sales growth and can they sustain this type of pricing? We build that into the investment strategy, and then structure the fund as part of an ETF. Would you call that driverless, or is that driven?” Mike Mount agreed with Barnard commenting “The more specific the sector or area you want exposure to, the more you want a driver there, because it is specialist, you’re playing a theme, is it going to play out or not?” He also asked Li whether the analysis being carried out at L&G ETF is more quantitative or qualitative commenting “If you tell me the way you construct this thematic ETF is more quantitative, I’m reassured.” Li offered that reassurance. “It’s quantitative in the way we construct the portfolio. We need to use some qualitative measures as these industries are specialist. Once it’s restricted, then it’s all quantitative. The last thing you want is concentration risk. We’re trying to aim for specialised and unique exposure so it can sit alongside other portfolio holdings. Our investment approach is different from other thematic funds or ETFs.” When using thematic ETFs it is important for advisers to understand the underlying positions in that ETF. Funds
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that take too broad an approach to a theme can create a high degree of overlap with other holdings and lead to unintended concentration risk – a point which Li was keen to make. Having an effective combination of long-term secular growth themes, active research, and systematic, transparent, and rules-based implementation is a powerful investment proposition. Overall, the growing importance and relevance of ETF structures was seen as a positive development and one which is here to stay. However, a greater focus on more detailed communications and information from providers in general was felt to be likely to underpin the support for advisers and investment managers. This would help them to feel even more comfortable having a greater understanding of the funds and being in a position to recommend them as a part of a diversified portfolio for clients, but also to keep up to date with changes over the long term so that they can continue to reassess their relevance as an ongoing part of that balanced portfolio as part of the review process. And finally, we hope that IFA Magazine readers will be pleased to hear that we will be following up with more coverage on ETFs in future editions of the magazine.
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