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Determining the value of low-cost ETFs

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“Any makeover ETFs have had has only been skin deep but at heart they are the same,” he says.

The basic structure of ETFs, the buying and selling intraday on an exchange continues to function well, despite the worst the markets have thrown at them.

“Just as the cost of Barry Manilow’s CDs fell as online streaming gained popularity, ETFs have become a whole lot cheaper in the past 10 years. Cut-throat competition from new entrants has forced down prices. A decade ago an S&P 500 ETF would have cost you 0.40%; today it is around 0.04%.

“As fees on ETFs have fallen, issuers have scouted around for new ‘value added’ ideas that might prove to be the next hit. This has led to a constellation of smart beta and thematic ETFs.

“The longest-running hits have been the higher-dividend ETFs, but also thematic ETFs such as robotics and cyber-security have shot up the charts.

“We have nearly always had fixed-income ETFs but offerings in areas such as high yield and emerging market bonds have introduced investors to new styles.

“A lot of the indices ETFs have followed are bespoke and ‘liquid’ to enable the issuers to keep their intraday trading promise and also illustrate the limits of ETF investing, ie that they cannot go into illiquid areas of the market.”

“For example, the ETF issuers know they would have a guaranteed hit if they marketed something tracking cobalt or lithium for the electric car enthusiast, but the underlying market is not sufficiently liquid.

“Some issuers have also bought to market products that few investors really understand, such as the infamous Vix ETFs. In their simplest form these products stretched punters to their limits and at their most complex they were beyond nearly everyone, except those calculating the fee.

“The next 10 years will no doubt bring more of the same – greater choice and lower fees. Some of the labels may change but, ultimately, you will continue to be able to buy and sell ETFs intraday, on an exchange.”

Keeping an open mind

As costs come down and the ETF industry evolves we asked Ben Yearsley, a director at Shore Financial Planning, if his use of the products has grown during the past few years and whether or not he expects to increase their use going forward.

Despite the increased popularity and assets in ETFs, he says he still finds it difficult to fit them into client portfolios.

“First, mainstream platforms have been fairly slow in adopting anything that isn’t a traditional fund,” he says. “Second, apart from more specialist areas, such as sector-based or commodity ETFs, what are they giving me that’s not available elsewhere?

“I can get a leveraged FTSE 100 if I want, or short oil, but should I be using these in client portfolios? I suspect the answer is no for the majority of advisers.

“The simple answer is that I am not using ETFs any more than I did in the past. I have an open mind about all investment, yet I haven’t felt the need to push for inclusion of ETFs in client portfolios.

“I still equate ETFs with trading and not investing. Although I prefer active investing there are some markets where passives are more appropriate. But do I need to invest via an ETF over a passive fund? I don’t think so. Passive funds have improved in the past decade and now have more openness, transparency and, crucially, far better pricing.

“Should advisers be trying to play market volatility, trading in other words, or should they invest for the long term? My view is that you should invest for the long term and not attempt to time markets. From that perspective I won’t be increasing my use of ETFs owing to market volatility.

“ETFs do have an advantage over [any mutual fund] in this environment due to live pricing but if you are investing for the long term, again, it shouldn’t matter. Indeed, live pricing creates its own problems – when do you trade for clients, for example?

“There is no reason to suggest ETFs will be any better or worse than [mutual] funds in a volatile environment but it will be incumbent on advisers to use them sensibly.”

 

Adam Lewis

Adam has been a freelance journalist and content editor since 2015. A journalist and editor with over 15 years experience, until 2015 he worked as editor of Fund Strategy for three years, and worked on...

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