The rise of the ETF portfolio

Apr 19th, 2016 | By | Category: Alternatives / Multi-Asset

When the Retail Distribution Review (RDR) came into force at the beginning of 2013 the exchange traded fund market expected to see a surge in uptake, but advisers were hesitant to use ETFs despite their low cost and liquid nature. That was until recently. Increasingly, there are signs that advisers are beginning to embrace ETFs through direct allocation and via outsourced model portfolios, and many market watchers believe their use is set to boom.

The rise of the ETF Managed Portfolio

The rise of the ETF Managed Portfolio

Research put out in November last year from ETF provider Source showed that independent financial advisers (IFAs) want more ETFs to be put on platforms so they are more readily accessible.

The research revealed that 82% of IFAs believed that ETFs needed to be more widely available on platforms, while 28% said a significant increase in the number of these products available on platforms will help the sector grow.

The news will be encouraging to an ETF market that has been struggling to tap into the IFA space for the last few years.  It was reflected in data from the same report that showed 42% of IFAs believed that their clients had no exposure to ETFs, while around 49% estimated that between 1% and 10% of their clients are invested in ETFs. Despite this, 34% of IFAs expected their clients to increase their exposure to ETFs over the next year, compared to just 4% who expected exposure to decline. 

Allan Lane at Twenty20 Investments explained that the market is only now beginning to see real uptake of IFAs in ETF portfolios. “This is because the ETF tidal wave is just too big to ignore.”

Similarly, Ben Seagar-Scott at Tilney BestInvest argues that their use in passive portfolios is a natural evolution in the rise of ETFs. He said: “Launching low cost passive portfolios is more feasible than it has been in the past and demand seems to be coming both from the retail investors directly and IFA.

“If you look at the US, which is a little ahead of us in terms of adoption of ETFs at a large scale, there are a lot of these sorts of portfolios.”

Interest is growing

The data supports this. In a recent study by BlackRock of 40 asset management firms across the US, it found that ETF managed portfolios are set to be a fast growing part of the ETF industry. And despite the UK being some way behind the US, in terms of IFAs using ETFs, there is evidence that uptake and use of passive portfolios is increasing.

Fund platform Novia launched smart beta ETF managed portfolios for UK advisers this month, while Tilney BestInvest launched smart beta passive portfolios in January. The five risk-rated multi asset UCITS OEIC funds include a high proportion of exchange traded products with the Cautious portfolio holding 59% of ETFs, Balanced 57%, Growth 60%, Aggressive Growth 62% and Income 60%.

Among others, another firm using ETFs regularly in its model portfolios is Price Bailey. It currently runs portfolios with around 65% in ETFs and index funds, and 35% in active strategies. The firm uses ETFs and index trackers because, it says that, on a long-term basis active managers won’t outperform in some of the major markets.  

Separate data from Novia also reflects this sentiment, showing that in the last year there has been an uptick in investment of 75% in ETFs, while 52 of the 65 discretionary fund managers (DFMs) (80%) on its platform are using ETFs in model portfolios.

Bill Vasilieff, CEO of Novia, said: “There is a constant effort by the ETF industry to break into the IFA market and it coincides with a rising disinterest in active management.  I am convinced there will be an uptake in passive investing because research shows that active management underperforms and you pay a lot for it.”

Hurdles remain

The benefits of ETFs are well known: they are low cost, they can access almost any market and because they are traded intraday investors can get their money out if they need. But there are still some hurdles the market needs to overcome to really take off.

IFAs have traditionally focused on unit trusts and OEICs. And in many cases continue to do so.

Vasilieff explains that ETFs offer investors a low cost opportunity to invest in a level of detail that unit trusts and open-ended investment companies don’t.  But people just aren’t aware of what an ETF can do when compared with a tracker.

Tilney’s passive portfolios, while comprising a high portion of ETFs are launched as UCITS OEIC fund-of-funds because of the control the managers can then have over the portfolios – they are managed on a daily basis.

Seagar-Scott argues that there are a number of specific challenges in Europe which still need to be overcome. “ETFs have been the preferred vehicle for the recent raft of launches, so part of this is a case of going where the products are. Although there are certain structural differences between listed and unlisted funds (bear in mind that ETFs are open-ended vehicles, much like OEICs and Unit Trusts as well), essentially from an investment strategy point there is little reason to favour one over the other, unless you specifically need to trade intraday.”

Is smart beta suitable?

Interestingly, while Twenty20’s Lane says that smart beta is attracting fund managers to venture into the ETF space, he argues that smart beta is not well suited to retail investors. “In the past we have seen active fund managers shy away from the ETF industry because the margins weren’t big enough, but with smart beta they are. But I am not convinced that smart beta is a product well suited to retail investors. They are too much to deal with and are not non-sophisticated user friendly.”

Seagar-Scott adds that ‘smart beta’ is a broad term that covers a wide range of strategies, so it’s difficult to generalise, but he warns that investors should make sure they understand any investment product they are looking to invest in before they actually make their investment and smart beta is no exception.

He said: “This is true for active management as well as ‘smart beta’ and passive investment, though due diligence on the methodology behind ‘smart beta’ is generally more involved than for a plain vanilla passive funds. One thing I think it is important to highlight is that these new products are not the ‘silver bullets’ that some seem to believe – like almost all other investment strategies, they have their own strengths and weaknesses which means they often have market conditions that favour them, and those that are more of a headwind.”

But Vasilieff says that smart beta is just non-market cap rules based approach.

“We back the rules-based concept of smart beta. It takes all the emotion out of investment decisions and it is better than market cap.” He concedes that it is more expensive though, “but that’s because you’re paying for the intelligence.”

Peter Sleep, senior portfolio manager at 7IM, adds, “We use quite a lot of smart beta in our portfolios and we have found that our financial planner partners are supportive. We have taken a great deal of effort to explain smart beta to them and how it will add value to their clients over time. We use our own equity value funds and we also use a RAFI Sovereign Global Bond fund managed by Kempen Capital Management.”

Platform problems

Another more common theme as to why ETFs aren’t top of IFAs’ agenda is the availability on platforms (as highlighted in the Source survey), with many still not yet offering them.

Sleep argues that most online platforms that financial planners use are an impediment to the uptake of ETFs because of their charging structure.

“My impression is that financial planners are more concerned about performance, value for money, and service, and are less concerned about how it is delivered. I think this is how it should be…. Most platforms charge between £10 and £25 for an ETF transaction, whereas tracking fund charges are zero. I therefore tend to favour tracking funds for most investment classes, even if the fees are a few basis points higher. I think this is fairer for small clients and regular savers who may find an ETF transaction charge prohibitively expensive.”

Vasilieff adds, “A lot of platforms can’t offer ETFs because they are re-developing their technology. In the past they have said that ETFs are risky and there isn’t enough demand (which isn’t true) because they can’t offer them.”

Looking ahead

Despite these issues, the user pool of ETFs is growing.  Last November iShares held a media roundtable with Fidelity, Novia and Brewin Dolphin. It found that the increasing trend of financial advisers outsourcing investment management to DFMs was driving demand for ETFs in the UK. It also found that the platforms that were able to provide DFMs with the most cost effective and granular exposures had the best advantage in the market.

Robin Beer, National Intermediary manager at Brewin Dolphin, explained at the iShares roundtable event that ETFs play a key role in delivering value to clients. “As one of the leading providers of outsourced discretionary fund management, building cost-effective portfolios without sacrificing flexibility and granularity is an ongoing challenge….Providing advisers with risk appropriate portfolios for their clients relies on broad investment access and choice to make sure our market views are expressed in the most efficient way. We would like to see a broader group of platforms integrate ETFs into their platform offering alongside other tools to provide greater choice.”

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