‘Are they vanilla?’ is the first question you should ask about ETFs, or exchange-traded funds: so says veteran multi-family office director Adam Wethered. Do you think of them as passive trackers with low volatility, or as a vast range of products in pursuit of more exotic investment themes? ‘Are they the straightforward, physically-backed sensible thing or do they have kinks in them?’
ETFs were born in the late 1980s as simple ‘index trackers’, but have flourished since the millennium with more and more wrinkles added to the prune. Peter Lowman of wealth management firm Investment Quorum says: ‘We use them as an entry-point product. There are times when you want to use a cheap investment tool to get into the markets and there are times when you don’t actually want to own the whole market. For example, we’re sitting currently pretty close to an eight-year bull market and there are a lot of rich valuations around, in equities and bond markets. We’re currently using ETFs in certain markets where we think there might be some value.’
Lowman favours an S&P500 ETF as a way of investing in US equities, his reasoning being that it is an incredibly tough index for an active manager to beat: ‘It’s difficult to find companies that 150-analysts aren’t looking at, so an active manager-buying S&P stocks is going to have to be more nimble than research-driven. The S&P500 is something we use as a core position, purely because it gets us in that-market, we’re always in the market, and all we need to do then is add or trim, depending on whether we’re bullish or bearish. Around that we’ll use one or two active-managers to pick stocks.’
There are ETFs to suit every taste — and whether quoted here or in the US (and dollar-denominated), they are easy to buy and sell. Smart ‘beta’ ETFs aim to go beyond wider indexes and focus on attributes such as company size, earnings growth, dividends, value, momentum and volatility. Some of them-combine multiple factors. As long as it can be measured, anything investable can form the basis of an ETF.
And just as the investment world was once enamoured of ‘funds of funds’, so there are ‘ETFs of ETFs’, while smart beta ETFs are now so prevalent, and their stories so apparently compelling, that it might be wise to be wary of them. After all, a story is one thing; an instrument that generates an actual return is another.
Commodities are another area where ETFs serve a useful purpose, creating exposure without having to take delivery. Rather than keep bullion in a home safe or a depository, you can buy an ETF in physical gold, silver or platinum.
But bear in mind that many active managers already own these within their own products. Lowman cites Sebastian Lyon of Troy Asset Management, whose Trojan Fund portfolio has a significant holding of gold bullion through ETFs as an insurance against another global financial crisis. Lowman prefers to leave the timing of getting in and out of gold bullion to a top-notch active manager such as Lyon.
Traditionally, ETFs have been seen as a way for both private and institutional investors to gain access to foreign markets. Indeed, as Elliot Wilson writes on page 14, this is by far the easiest way to invest in the growth narrative of some emerging markets.
Vietnam, which has a dynamic growth economy (GDP expected to grow by 6.7 per cent this year), is a case in point. There is the Market Vectors Vietnam ETF, which tracks the MVISA Vietnam Index — but it is costly at 0.76 per cent commission and has depreciated by 44 per cent since it was launched in 2008.
Turkey is another fast-growing economy, although we should expect volatility following the recent coup and its repressive aftermath, as well as continuing terrorist threats there. For the record, there’s also an Egypt ETF — but that one is probably best avoided for the foreseeable future.
On the other hand, the Australian market is currently underperforming (relative to the S&P500, for example), owing to negative perception of the country’s four big banks which account for a large proportion of the index. But analysts believe that this perception will adjust, and therefore that investing in the S&P ASX 200 over the next year could generate a return of around 10 per cent. You can get in on the act via the iShares MSCI Australia ETF.
Again, ETFs can offer exposure to truly niche themes in the field of technology. How about investing in robotics and artificial intelligence, for example? Well, you can always try the Global X Robotics and Artificial Intelligence Thematic ETF. Or how about the world of 3D printing, which some believe is set to revolutionise manufacturing? Well, you can try the 3D Printing ETF, which has already gone up in value by around 15 per cent since it was launched in mid-July.
And then there’s that other technological revolution that’s just around the corner, the so-called-‘Internet of Things’. Cisco Systems, which has plenty of skin in the game, reckons the Internet of Things will consist of 50 billion devices connected to the internet by 2020 and McKinsey have calculated it could generate $11 trillion in value by 2025.
Does that get you excited? In which case, you could try the Global X Internet of Things Thematic ETF, which holds stocks in companies likely to benefit from these developments, with a 6 per cent cap on any single stock.
Don’t let’s get started on other exotic ETFs which rely on strategies rather than themes. Suffice it to say that if you want an ETF that will target companies generating high and growing dividends, rest assured it’s out there.
Researching such exotica can be a lot of fun, but you will need to drill down into the details, in-particular benchmark construction, portfolio composition and hidden costs. Arcane ETFs are probably best left to the professionals or the ‘sophisticated’-private investor.
The latest exotic ETF to be mooted is one for cash — yes, cash. How so, you might well ask? A couple of weeks ago, M&G bond manager Richard Woolnough suggested that if the low-interest-rate-environment persists or goes negative, an ETF provider might offer to hold large quantities of physical cash on your behalf — on the basis, presumably, that at least it would be better than keeping it under your bed.
‘One solution would be for a bank to issue an ETF based on negative-yielding cash, akin to other physical ETFs,’ he said. ‘As opposed to commodity or equity backing, the ETF would have cash stored safely at a variety of locations, where security would be strong and access would be hard to achieve. The ETF-provider could then charge the client a fee (say 1 per cent per annum) for depositing the cash, incur low costs of storage of let us say 0.5 per cent, and earn 50 basis points of return. Such an ETF would allow customers from individuals to institutions to store their money efficiently at a zero rate before fees.’
It hasn’t happened yet, but the very fact that the notion is being bruited abroad shows how ingenious the world of ETFs can be.