Elston's Henry Cobbe, Head of Research discusses ETF trends on Bloomberg ETF IQ programme.
Watch the Video BMO has lowered the cost of its bond ETF range by -43% from 30bp to 17bp as it passes through the economies of scale to end investors.
BMO’s bond ETFs offer access to the global corporate bond market, whilst giving investors the choice to select their preferred exposure, as defined by maturity. iShares offers the most popular London-listed global corporate bond ETF (CRPS). This tracks the Bloomberg Barclays Global Aggregate Corporate Bond Index at 0.20% TER. Its GBP-hedged version (CRHG) understandably costs slightly more at 0.25% TER for the convenience of in-built currency hedging. Like iShares, BMO also offers a GBP-hedged range, but has a more nuanced approach by offering investors a choice of three different ETFs each with a different maturity range: 1 to 3 years (ZC1G), 3 to 7 years (ZC3G) and 7 to 10 years (ZC7G). This compares to the average maturity of the main index of approximately 9 years. The ability to access this exposure by maturity is particularly useful for UK institutional and pension scheme investors who are looking to construct liability-relative portfolios where both duration and currency controls are important to avoid asset-liability mismatches. The BMO range has gathered some £117m AUM since launch in November 2015 (inflows of £3m per month on average). This compares to iShares' CRPS size of £824m since launch in September 2012 (inflows of £12m per month on average). As the advantages of bond investing with ETFs become more apparent (secondary liquidity, transparent exposure, daily disclosure of underlying), we expect increasing price competition and greater nuance within the most popular strategies. ETFs mentioned ZC1G BMO Barclays 1-3 Year Global Corporate Bond (GBP Hedged) 0.17% TER ZC3G BMO Barclays 3-7 Year Global Corporate Bond (GBP Hedged) 0.17% TER ZC7G BMO Barclays 7-10 Year Global Corporate Bond (GBP Hedged) 0.17% TER CRPS iShares Global Corporate Bond (Unhedged) 0.20% TER CRHG iShares Global Corporate Bond (GBP Hedged ) 0.25% TER (All ETFs mentioned are UCITS ETFs listed on the London Stock Exchange)
What are CoCos? Following the 2008 financial crisis, banks had difficulty issuing traditional debt securities, and had to sit on a large amount of capital to ensure their balance sheet strength was maintained. CoCos were created as the issuing banks flexible friend. This is because are designed to absorb losses when the balance sheet of the issuing banks weakens below a threshold level. Losses can be absorbed by the CoCo converting into equity or suffering a write-down of its principal value making it more flexible than traditional bank securities. To offset the risk of loss, CoCos are issued with a higher coupon than traditional bank bonds. Accessing CoCos Whilst bond funds may include CoCos, direct access to CoCos as a targeted allocation was previously only available to institutions who could meet minimum issuance sizes from one or more issuer. By accessing CoCos using an ETF, the minimum investment drops to $100, and the ETF is diversified across 29 CoCos from 24 different issuers. Why include CoCos in a portfolio? Convertibility into the issuing bank’s shares means that CoCos provide an exposure that has both bond and equity-like characteristics. When there is higher risk of balance sheet stress, CoCo's behave more like equities. When there is lower risk of balance sheet stress, CoCo’s behave more like bonds. CoCos' moderate correlation to equities and low correlation to Corporate and Government Bonds makes them a useful diversifier from a portfolio construction perspective. Fig.1. Correlations to major asset classes Bigger income & better credit quality CoCos have an attractive income to reward risk taken, but a better quality credit rating compared to traditional High Yield Bonds. Fig.2. Income Profile Fig.3. Credit Profile Furthermore, in terms of counterparty risk, CoCos are only issued by large banks that are well regulated with high capital ratios. How about performance? CoCos have outperformed EUR bonds and equities, both excluding and including Financials exposure. Fig.4. Total Returns CoCos are positioned between equities and bonds in respect of realised volatility, but with better risk-adjusted returns. Fig.5. Risk-Return In summary, CoCos have offered solid risk-adjusted returns (Sharpe Ratio), and have a low correlation to bonds from a diversification perspective and a higher income with better credit quality relative to traditional high yield bonds.
Following our initiation of overage of the UK Equity Income Index/ETF universe (data to 4q17), we have updated the data for 1q18 performance update for selected indices.
Returns For 1q18, the most defensive UK Equity Income index was the MSCI UK Select Quality Yield, tracked by ZILK, at -5.49% compared to -7.21% for the FTSE 100. On a 1Y basis, 90%xFTSE 100 returned +0.2% tracked by ZWUK, followed by -0.24% MSCI UK Select Quality Yield tracked by ZILK has performed best. On a 3Y basis our proxy benchmark for ZWUK, which takes 90%xFTSE100, returned +15.4%,, followed by +11.4% for FTSE 350 ex Inv Trust Qual/Vol/Yield Factor 5% Capped tracked by DOSH. Risk Adjusted On a 3Y basis, 90%xFTSE 100 as a proxy for the benchmark tracked by ZWUK, followed by FTSE 350 ex Inv Trust Qual/Vol/Yield Factor 5% Capped tracked by DOSH, have delivered best risk-adjusted returns. Correlation On a 3Y basis, the FTSE UK High Dividend Low Volatility Index tracked by UKHD offers most differentiated returns relative to the FTSE 100 (lowest beta and correlation). Gross Dividend Yield Over the last year WUKD has offered the highest historic dividend yield. View Report Learn about ETF Research Visit SEARCH ETF<Go> on the Bloomberg Terminal
“Mutton dressed as lamb” is a derogatory old saying of something or someone that’s dressed up to look better than it is. In olden days, some dodgy butchers would dress mutton up to look like lamb to get a higher price. I’ve got nothing against mutton. It offers good value for money and does a nutritious job. But I don’t want to be given one thing when sold another. Some “active” funds that actually hug an index is another form of misrepresentation. And this month, the UK regulator got tough forcing a number of fund houses to pay £34m compensation to customers overcharged in closet index funds. As this is the first closet indexing fine of its kind internationally, it’s worth taking a closer look. What happened? The furore is around “closet indexing” where mutual funds charge active fees to deliver an investment style that pretty much tracks the index which it aims to outperform. When marketed as active, this is misrepresentation. Furthermore, closet index funds offer poor value for money compared to genuine index-tracking fund or ETFs for the same given exposure. What exactly is closet indexing? “Closet indexing” is a term first coined – in public at least – by academics Cremers & Petajisto in 2009. The study and metrics around “active share” and “closet indexing” caused a stir in the financial pages on both sides of the Atlantic as active managers started to watch the relentless rise of ETFs and other index-tracking products. In 2016, ESMA – the pan-European financial services regulatory coordinator – undertook a study whose findings were published in 2016, outlining the potential scale of the problem in Europe. In a Market Study published by the UK regulator in June 2017, the FCA put asset managers on notice that it would be investigating closet index funds as an area that offers poor value for money for customers and potential misrepresentation. In March, the UK regulator struck after sampling funds from 19 UK asset management firms. Of the 84 suspected closet index funds reviewed, the FCA required changes to the descriptions of 60 funds to ensure they were not misleading. Furthermore, an undisclosed number of unnamed firms managing an undisclosed number of funds were required to compensate their customers £34m: not for providing index-like returns, but for saying one thing and doing another. To be clear, the issue around closet index funds is not simply about fees. It’s as much about transparency and customer expectations. How can you define “closet indexing”? There has been some speculation as to what methodology the FCA used to deem funds a closet indexer. In this respect, ESMA’s 2016 paper may be informative. Their study applied a screen to focus on funds with 1) AUM over EUR50m, 2) an inception date prior to January 2005, 3) Fees of 0.65% or more, and 4) were not marketed as index funds. Having created this screen, ESMA ran three metrics to test for a fund’s proximity to an index: active share, tracking error and R-Squared. The Closet Index Metrics in summary Active share shows the percentage of the portfolio that does not coincide with index. Tracking Error shows volatility of difference in return fund and index. R-Squared represents the percentage of fund performance explained by index performance – a correlation measure. On this basis, a fund with low active share, low tracking error and high R-Squared means it is very similar to index-tracking fund. But what are the thresholds for each metric and how many funds are caught in the net? A trillion euro problem? ESMA sets out three thresholds – each increasingly stringent – by which closet indexing could be defined. These are set out in the table below: ESMA Closet Index Evaluation Thresholds Threshold/Tracking Error/% of European Active Funds/Est 2016 AUM Affected Active Share <60%/TE <4%/15%/€1,200bn Active Share <50%/TE <3%/7%/€560bn Active Share <50%/TE <3% & R2 >95%/5%/€400bn Source: ESMA, Elston Based on Morningstar data we estimate the European funds industry to be approximately €8tr in 2016, implying on our estimates €1.2tr could be defined (at its loosest definition) as closet indexing, with €400bn (at its tightest definition) coming under particular scrutiny. Where next for fund houses? Fund houses in the UK and Europe have some thinking to do. Are they offering building block components, or managing solutions? Our view remains that those offering solutions will prosper, whilst those offering building blocks risk commoditisation. Price pressure from index funds and ETFs has been present for a while, but so far traditional brands and distribution networks have proven resilient. But with the regulator now joining in to target closet indexers, the “big switch” for core exposures from actively managed funds to index-tracking funds is likely to accelerate, in our view. Embracing change Rather than embracing change, European asset managers that don’t currently offer ETFs have so far been hesitant to launch. They should get over it. Fund houses have embraced different fund wrappers which have over time: investment trusts (one of the earliest just celebrated its 150th anniversary), unit trusts, OEICs, SICAVs, ICVCs to name a few. ETFs are just a not-so-new tradable way of delivering a basket of securities to the investor. Technology changes. Purpose does not. So European asset managers should launch, not fear, ETFs. Or watch their American cousins eat an ever cheaper lunch. A winning formula Tomorrow’s winners in the European asset management space, in our view, are those firms that are: 1) close to asset owners; 2) can offer solutions as well as components; and 3) are part of the low-cost revolution, not victims of it. Fund houses that meet all three of these tests are in good shape. There are some big British behemoths that don’t yet meet those tests. Unless they act, they risk getting left behind. Indexing and proud Index investing is transforming the UK retail investment landscape. It is creating a Moore’s Law for the fund manufacturing. It’s time to get involved. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: This article has been written for a UK audience. Tickers are shown for corresponding and/or similar ETFs prefixed by the relevant exchange code, e.g. “NYSEARCA:” (NYSE Arca Exchange); “LON:” (London Stock Exchange). For research purposes/market commentary only, does not constitute an investment recommendation or advice, and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product. This blog reflects the views of the author and does not necessarily reflect the views of Elston Consulting, its clients or affiliates. For information and disclaimers, please see www.elstonconsulting.co.uk Photo credit: as per specified source; Chart credit: as per specified source; Table credit: as per specified source. All product names, logos, and brands are property of their respective owners. All company, product and service names used in this website are for identification purposes only. Use of these names, logos, and brands does not imply endorsement. Interview with Henry Cobbe, Head of Research, at the TrackInsight ETF Investor Summit Watch the video
UK Equity Income Indices Investors have a choice of UK Equity Income index strategies, each with different risk-return characteristics, weightings methodologies and factor tilts. These difference influence the performance of each index strategy (all figures below are on a total return basis for GBP investors). Best performing for 2017 The best performing strategies for UK Equity Income in 2017 were:
This compares to +12.3% for FTSE 100 (best tracked by HSBC FTSE 100 UCITS ETF (LON:HUKX)). Best performing over last 3 years The best performing strategies for UK Equity Income over the last 3 years were:
This compares to +31.5% cumulative return for FTSE 100 (best tracked by HSBC FTSE 100 UCITS ETF (LON:HUKX)). Fig. 1: Total Returns (Cumulative) by strategy/index (cumulative, GBP terms) Best risk-adjusted returns The best risk-adjusted returns in 2017 of available UK Equity Income indices was achieved by:
To look at consistency of risk-adjusted returns, we have plotted 1Y Sharpe ratios vs 3Y Sharpe ratios for each UK Equity Income index strategy in Fig.2 below. Fig.2. 1Y & 3Y Sharpe Ratios, selected UK Equity Income index strategies (GBP terms) Conclusion Different index construction methodologies has a material impact on performance outcomes – both in absolute terms and on a risk-adjusted basis. A naïve interpretation is to consider performance in isolation, however our view is that index selection is more nuanced than that: it should relate to the objectives and constraints of individual client portfolios and the desired exposure - on asset-basis, risk-basis and factor-basis and the interaction between the selected strategy and the rest of a client portfolio. Note: Scope of our comparison For these reports, we have analysed the indices and ETFs detailed in Fig.3. Fig. 3: UK Equity Income Indices & ETFs vs HSBC FTSE 100 UCITS ETF (LON:HUKX) [ENDS]
NOTICES: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. This article has been written for a US and UK audience. Tickers are shown for corresponding and/or similar ETFs prefixed by the relevant exchange code, e.g. “NYSEARCA:” (NYSE Arca Exchange) for US readers; “LON:” (London Stock Exchange) for UK readers. For research purposes/market commentary only, does not constitute an investment recommendation or advice, and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product. This blog reflects the views of the author and does not necessarily reflect the views of Elston Consulting, its clients or affiliates. For information and disclaimers, please see www.elstonconsulting.co.uk Photo credit: N/A; Chart credit: Elston Consulting; Table credit: Elston Consulting All product names, logos, and brands are property of their respective owners. All company, product and service names used in this website are for identification purposes only. Use of these names, logos, and brands does not imply endorsement. Chart data is as at 30-Dec-17
Focus on market cap indices is a choice, not an obligation A market cap weighted approach has well known drawbacks: it biases larger companies, regardless of efficiency and is "procyclical" - buying larger amounts of more expensively valued companies. This is a critique of "passive investing". We don't believe there's such a thing as passive investing. There is index investing and non-index investing. There is subjective investing and systematic investing. Choice of index, choice of methodology, choice of asset allocation are all active decisions. Index investing simply delivers the desired investment approach in a way that is efficient, transparent and cheap. Factor-based indices The arrival of factor-based indices, means that for a required World Equity exposure, we can select which factors we want exposure to: for example, Size, Momentum, Quality, Value or Minimum Volatility. The different factors can be summarised as follows:
How have these different factors fared? Ranking the 1Y performance of these factors in 2017: Momentum factor delivered the highest total return at +20.6%, followed by Size factor at +13.1%, followed by Quality factor at +12.5%, followed by Value factor at +11.5%, and finally Min Volatility at +7.1%. This compares to +13.2% for the traditional cap-weighted approach. Fig 1. Equity Factor 1Y Realised Risk-Return On a 3Y basis, the annualised returns of Momentum come in at +18.2%, followed by Size at +15.7%, followed by Quality at +15.2%. This compares to +14.6% for the traditional cap-weighted approach. Fig 2. Equity Factor 3Y Realised Risk-Return Risk-Adjusted Returns Ranking the 1Y risk adjusted performance by Sharpe Ratio: Momentum leads at 1.94, followed by Size at 1.44, followed by Quality at 1.30. This compares to 1.37 for the traditional cap-weighted approach. On a 3Y basis, Size leads at 1.33, followed by Momentum at 1.30, followed by Quality at 1.19. This compares to 1.15 for the traditional cap-weighted approach. In Fig 3. we plot the 1Y and 3Y Sharpe ratio for each World Equity factor relative to traditional cap-weighted Global and EM Equity indices, to compare the risk-adjusted returns of different factor exposures over different time frames. Fig 3. Equity Factor Sharpe Ratios Conclusion: a differentiated approach
We are not suggesting that one factor approach is inherently superior to another. But with a broader array of factor exposures readily accessible to decision-makers to match with their portfolio requirements, there's no longer need to complain about the limitations of cap-weighted indices. NOTICES: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. This article has been written for a US and UK audience. Tickers are shown for corresponding and/or similar ETFs prefixed by the relevant exchange code, e.g. “NYSEARCA:” (NYSE Arca Exchange) for US readers; “LON:” (London Stock Exchange) for UK readers. For research purposes/market commentary only, does not constitute an investment recommendation or advice, and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product. This blog reflects the views of the author and does not necessarily reflect the views of Elston Consulting, its clients or affiliates. For information and disclaimers, please see www.elstonconsulting.co.uk Photo credit: N/A; Chart credit: Elston Consulting; Table credit: Elston Consulting All product names, logos, and brands are property of their respective owners. All company, product and service names used in this website are for identification purposes only. Use of these names, logos, and brands does not imply endorsement. Chart data is as at 30-Dec-17
UK Equity Income ETF Choices Investors have a choice of UK Equity Income index strategies, each with different risk-return characteristics, weightings methodologies and factor tilts. Portfolio managers and advisers considering a UK Equity Income ETF should understand the differences of each to inform their selection process. In the first of a series of studies of this key sector, we have done a sector analysis of London-listed UK Equity Income ETFs, to understand their inherent characteristics relative to the UK main equity index, the FTSE 100. For these studies, we have analysed the indices and ETFs detailed in Fig.1. Fig. 1: UK Equity Income Indices & ETFs vs HSBC FTSE 100 UCITS ETF (LON:HUKX) Methodology impact on sector allocation The result of the application of various index methodologies to the UK equities opportunity set materially impacts the sector exposures of available Equity Income ETFs. In some cases, sector caps form part of the index rules. In other cases they do not. For example, the FTSE100’s bias to Energy and Financials is well documented. For some Equity Income strategies, such biases are mitigated or even eliminated. Selecting the right Equity Income ETF for the business cycle For investors that focus on the business cycle, we have analysed the available UK Equity Income ETFs by GICS sectors, and classified those GICS sectors into two broad groups – Cyclicals and Defensives. This enables us to rank UK Equity Income ETFs by their exposure to the business cycle. On this basis, investors wanting access to UK Equity Income with a Cyclical bias (coloured red in Fig.2. below), should consider (in order) LON:WUKD, LON:IUKD, and LON:HUKX. Conversely, investors wanting access to UK Equity Income with a Defensive bias (coloured grey in Fig.2. below), should consider (in order) LON:DOSH, LON:UKDV and LON:ZILK. Fig. 2: UK Equity Income ETFs by Sector Allocation vs HSBC FTSE 100 UCITS ETF (LON:HUKX) Conclusion
There is more to UK Equity Income than yield alone, by understanding the look-through sector exposures of the available UK Equity Income ETFs, investors can make more informed decisions as regards ETF selection that is consistent with their preferences, and client needs. NOTICES I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. This article has been written for a US and UK audience. Tickers are shown for corresponding and/or similar ETFs prefixed by the relevant exchange code, e.g. “NYSEARCA:” (NYSE Arca Exchange) for US readers; “LON:” (London Stock Exchange) for UK readers. For research purposes/market commentary only, does not constitute an investment recommendation or advice, and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product. This blog reflects the views of the author and does not necessarily reflect the views of Elston Consulting, its clients or affiliates. For information and disclaimers, please see www.elstonconsulting.co.uk Photo credit: N/A; Chart credit: Elston Consulting; Table credit: Elston Consulting All product names, logos, and brands are property of their respective owners. All company, product and service names used in this website are for identification purposes only. Use of these names, logos, and brands does not imply endorsement. Chart data is as at 30-Nov-17 Whilst advisers and investments are comfortable and familiar with the simple term “funds” (has anyone heard of an “CIS (Collective Investment Scheme) Conference” or being an “AUT (Authorised Unit Trust) investor”? There is much less familiarity with the once-institutional and now pervasive ETFs (Exchange Trade Funds). That lack of familiarity means that for some reason that particular TLA has stuck.
Claer Barrett in FT Weekend’s FT Money section tries to demystify the jargon – but ends up makes thing sound more complicated than they need to be. Advisers wanting to check or brush up on the difference between an ETP, ETF, ETN and ETC could do well to invest 2 hours of their time to earn accredited CPD (Continuous Professional Development) from the roadshow being run by Copia Capital Management to get a solid understanding of this increasingly popular and pervasive investment vehicle. As for civilians – customers and investors – it's actually quite simple. It’s about money. Client money. And how it gets put to work. So forget the TLAs and the alphabet soup of ET-this and ET-that. The key question to ask managers is “What are you doing for your fee, and how do I get to keep the most of my available return?” The investment management industry is waking up to the fact that its customers deserve more English-language dialogue, and fewer abbreviations. QED. NOTICES: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. This article has been written for a US and UK audience. Tickers are shown for corresponding and/or similar ETFs prefixed by the relevant exchange code, e.g. “NYSEARCA:” (NYSE Arca Exchange) for US readers; “LON:” (London Stock Exchange) for UK readers. For research purposes/market commentary only, does not constitute an investment recommendation or advice, and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product. This blog reflects the views of the author and does not necessarily reflect the views of Elston Consulting, its clients or affiliates. For information and disclaimers, please see www.elstonconsulting.co.uk Photo credit: squarespace,com; Chart credit: N/A; Table credit: N/A
Smart beta strategies are “smart” because they take a scientific, quantitative and objective approach to investing by combining a range of index-tracking ETFs with different market risk or “beta” exposures. In contrast to the opacity of hedge funds, dynamic allocation “smart beta” investment strategies should do what they say on the tin. Elston runs a number of diversified multi-asset investment strategies, two of which have been offered as indices for asset owners and investment managers to benchmark against or track. Chart 1: Risk and Return 2016 Source: Elston, Bloomberg, all in GBP Looking at outcomes Our multi-asset Global Max Sharpe index (Bloomberg: ESBGMS) did what it said on the tin delivering a Sharpe ratio (our primary measure of success for this strategy) of 2.06 for 2016, compared to 1.94 for Equities, 1.90 for Bonds and 1.45 for Commodities. On a returns basis (our secondary measure of success) the strategy returned 23.58% for the year, compared to 28.35% for equities, but with volatility of 10.35% compared to 15.45% for equities. Put differently, the strategy captured 83% of equity returns with just 67% of equity risk. Chart 2: Elston Multi-Asset Max Sharpe (ESBGMS) 2016 Outcome Source: Elston, Bloomberg, all in GBP Our multi-asset Global Min Volatility index (Bloomberg: ESBGMV) also did what it said on the tin whilst maintaining exposure to a broad set of return-seeking asset classes. The realised volatility (our primary measure of success for this strategy) for 2016 was 7.08%, compared to 15.45% for equities, 13.64% for bonds and 25.28% for commodities. Our dynamic asset allocation approach minimised portfolio variance whilst harvesting returns. On a returns basis (our secondary measure of success), the strategy returned 18.62% for the year, compared to 28.35% for equities, but with volatility of 7.08% compared to 15.45% for equities. Put differently, the strategy captured 66% of equity returns with just 46% of equity risk. Chart 3: Elston Multi-Asset Min Volatility (ESBGMV) 2016 Outcome Source: Elston, Bloomberg, all in GBP Theory and practice Our strategies constituent parts are ETFs representing a broad range of asset classes and geographies. The Sharpe of our Global Max Sharpe strategy’s whole is greater than the sum of its constituent parts. The Volatility of our Global Min Volatility strategy’s whole is less than the sum of its constituent parts. And that’s the intention. A low cost more consistent alternative to hedge funds? Hedge funds were popular because they provided differentiated returns and mitigated risk. In 2016, Hedge Funds returned 1.35% with volatility of 3.56%. Put differently, on average they captured just 5% equity returns, despite taking on 23% of equity risk. We plot out equity return capture (return relative to global equity return) and risk outlay (volatility relative to global equity volatility) for the main asset classes, our strategies and HFRX (all in GBP) in the summary matrix below. Chart 4: 2016 Return Capture vs Risk Outlay Source: Elston, Bloomberg
The problem with many hedge funds is that they are not doing what they say on the tin. They aim to provide diversified differentiated returns – but their process, statistically, amounts to trial and error, fraught with subjective bias. We seek to achieve similar outcomes, but using a clinically quantitative approach. To paraphrase a famous composer: “At the end of the day, it’s just maths.” What next? The Elston Strategic Beta multi-asset indexes were launched in December 2014. They are priced daily with index values available for free, factsheets are published daily. Our research strategies and indices are available for licensing.
Big dreams The cuddly caption announcing the move says “Smaller Fees means Bigger Dreams”, which is warm-hearted. But it’s also sort of fair. Today’s retail investor has more access to breadth and depth of international markets than our parents ever dreamed of (if they ever dreamed of that sort of thing). What does this mean, apart from being cheaper? Well firstly, Moore’s law applies to ETF pricing & capacity as much as it does to semiconductors. That’s not new or surprising. But the sustained deflationary pressure on fund fees is forcing the convergence of institutional and retail investment offers. This will create pressures on asset managers that do not adapt. Adapt to what? The quest for elusive alpha from security selection looks like the right way of solving the wrong puzzle. The puzzle to solve is how to design asset allocation strategies to help investors achieve their desired or required outcome. Put differently, investment houses need to offer solutions (or “dreams”?), not products (“funds, OEICs, ETFs”). Who are the winners? Market access has basically become commoditised, so the only value in the value chain is in distribution (having customers), and solution design (giving them what they want). Asset managers and financial adviser that embrace this new reality should flourish. Those that linger on in yesteryear’s product based world will gradually lose momentum. NOTICES: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. This article has been written for a US and UK audience. Tickers are shown for corresponding and/or similar ETFs prefixed by the relevant exchange code, e.g. “NYSEARCA:” (NYSE Arca Exchange) for US readers; “LON:” (London Stock Exchange) for UK readers. For research purposes/market commentary only, does not constitute an investment recommendation or advice, and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product. For more information see www.elstonconsulting.co.uk Photo credit: coinquest.com Chart & Table credit: N/A
Post-Brexit fears around commercial property values has led to managers of three UK property funds locking investors in. They fear a potential rush of investors to sell units following the Brexit result in the EU Referendum. Decisions to suspend will typically reviewed every 28 days. The funds affected are those managed by Standard Life, Aviva and M&G, totalling some £9bn of assets (see table). While the justification given – to “protect the interests of all investors in the fund” – is fair and reasonable, some investors may not be too happy to be locked in for potentially quite a scary ride. The paternalistic reading is that investors are being protected from themselves, as they are denied the temptation to panic sell. Funds that locked in investors in 2008 eventually “came good”. But while investors may agree that “buy and hold” is right for the long run, that’s not the same deal as “buy and be held prisoner at the manager’s will”. This episode shines a much needed spotlight on the opacity around the underlying liquidity within funds that trade in less liquid assets. As always, investment funds are only as liquid as their underlying holdings. One of the main reasons advisers give for using funds over ETFs is that daily liquidity is not necessarily important as their investors take a long-term view. This does however deny the opportunity to make tactical adjustments to changing economic circumstances, particularly event-driven ones such as the UK referendum. What this episode illustrates that by contrast to funds, ETFs benefit from better internal liquidity (they typically invest only in liquid securities), from better daily external liquidity (as they are both OTC and exchange-traded), and from active liquidity management (the creation and redemption of units through capital markets activity by the issuer). For UK investors whose property exposure was through ETFs which such as iShares UK Property UCITS ETF (LSE:IUKP) which tracks the FTSE EPRA/NAREIT UK Property Index, the flexibility remains whether to adjust exposure or to the ride this out. And for portfolio management, flexibility counts. In terms of underlying exposure, Property ETFs and Property Funds are similar but different. Whereas property funds may have direct exposure to commercial or residential property, property ETFs typically own shares in listed real estate companies. As Property ETFs are by nature “equity only”, they can be expected to have higher volatility than property funds that which have exposure to bond-like steady streams of net rental income from less liquid direct holdings. So if risk is defined by standard deviation, it is clearly higher for a property ETF. If risk is defined by liquidity, it is clearly higher for a fund. Aside from volatility, the level of yield from property ETFs relative to funds is comparable, while the overall fee level is of course much lower. Table: Fee Comparison For investors seeking exposure to UK property as an asset class, then exchange-traded liquid ETFs that provide that from a portfolio construction perspective. But importantly, property ETFs won’t share the underlying liquidity risk that is (now) all too apparent.
NOTE Funds compared are iShares UK Property UCITS ETF (GBP), Standard Life Investments UK Real Estate Fund Retail Acc, Aviva Investors Property Trust 1 GBP Acc, M&G Feeder of Property Portfolio Sterling A Acc. Returns data as of 5th July 2016 (except M&G as of 4th July 2016). Standard deviationfigures as of 30th June 2016 for all funds. NOTICES: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. This article has been written for a US and UK audience. Tickers are shown for corresponding and/or similar ETFs prefixed by the relevant exchange code, e.g. “NYSEARCA:” (NYSE Arca Exchange) for US readers; “LON:” (London Stock Exchange) for UK readers. For research purposes/market commentary only, does not constitute an investment recommendation or advice, and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product. For more information see www.elstonconsulting.co.uk Photo credit: pictogram-free.com. Table credit: Elston Consulting |
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