ETFs are often marketed simply as low cost, simple solutions – the ‘own brand’ staple of the investment world. While they are certainly a cost-effective way to invest, there are other important benefits which are often overlooked.
Exchange-traded funds (ETFs) provide an easy way to gain exposure to a pool of investments without having to buy each one individually. They can track a share index, such as the FTSE 100, an asset class, such as government bonds, a market segment, such as bonds maturing in fewer than five years, a region, or a sector.
While the key attractions of ETFs are low cost, transparency and daily dealing, they offer investors many other benefits.
Asset class choice
The ETF market has ballooned in recent years, offering asset allocators a wonderful range of opportunities.
Do you prefer government bonds from developing economies to those issued by the UK? Do you believe small and mid-size companies will do better than large multi-nationals? Do you want to benefit from strong growth in Indonesia? Do you want to buy just companies within a certain industry or sector?
ETFs offer an easy way to access all these opportunities and diversify your portfolio.
ETFs also allow retail investors to invest in some assets that they simply wouldn’t be able to access otherwise due to accessibility or cost – such as commodities or physical gold. They have truly democratised the investment landscape.
There are very few opportunities that cannot be accessed via an ETF (for example, physical property). In those cases, a ‘closed-ended’ fund (like an investment trust) would be a better alternative.
One of the lessons of the global financial crisis is to always know exactly what you’re invested in. We never buy ‘synthetic’ ETFs – a financial contract with a bank to provide a return. With ‘physical’ ETFs you can easily see what is under the bonnet, as each provider publishes a daily list of all the underlying holdings. This allows us to analyse the concentration to any one country, sector or company, and manage risk more effectively.
This differs from mutual funds, where holdings are typically only made public with a month delay. Additionally, ETFs give us transparency of cost for trading, as we’re always able to see what we’ll pay or receive before we transact.
We believe that some active fund managers can add value. However, high fees often take away most of the gain. For every good active manager you pick, you’re just as likely to choose a bad one – a zero-sum game.
Active managers need a long time-horizon to prove themselves, so only after holding a fund for at least five years can you look back and say whether one fund was better than another. This is where ETFs score highly – you reliably earn the return of the market, year in year out, and, in some cases, more!
Unlike a mutual fund, which trades at one set price point during the day, ETFs can be traded whenever the stock exchange is open.
This provides added flexibility in portfolio management – for example, if you’re trading a fund that contains US stocks, it will likely be more efficient to do this when the US markets are open.
Using a range of ETFs from different providers, we can construct a diverse, multi-asset portfolio based on our view of prospect returns for global markets. Such a combination typically has an ongoing ETF cost of just 0.19%, compared to around 0.85% for active funds1. Over the lifetime of an investment portfolio, this improvement in the after-cost return could be very significant.
Risk warning: As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past or future performance indicators are not a reliable indicator of future performance.
1. Morningstar, all IA sector funds primary share classes as at July 2017, calculated on an asset weighted basis