January 31, 2014 7:34 pm

Lifting the lid on the secrets of ETFs

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Eye on the prize: ‘much of the information available [to the private investor] is not very reliable’

Imagine investing in an exchange traded fund is like buying a car. When an institutional investor walks into a showroom, he or she wants to know the precise technical specifications of the car while a retail investor wants to know basic facts, such as miles per gallon and acceleration.

Unlike buying a car, however, institutional investors are spoiled for choice when it comes to technical ETF data sources: they can choose from five to six robust providers. These provide just the kind of information they require, such as assets contained by the fund, the security lending policies, how closely the ETF tracks the underlying index and the fees.

But it is much harder for retail investors to find reliable sources of basic information on an ETF that would be the equivalent of a car’s fuel consumption. Providers are only just starting to target the independent financial adviser market specifically, while fund supermarkets such as Hargreaves Lansdown have begun to publish some simple information, such as ranking ETFs by popularity. Alan Miller, chief investment officer of SCM Private, says: “Not only is there a huge shortage of information available to the private investor, but much of it is not very reliable.”

Michael John Lytle, chief development officer at Source, says: “It’s not surprising the bulk of the research on ETFs is targeted at the institutional investors as they make up 90 per cent of the market in the UK.”

The introduction of the retail distribution review, however, is starting to change that dynamic. “There is more focus in the UK on the retail investors buying and owning ETFs but the actual trading and holding of ETFs is still quite small compared with a fully developed market like the US,” says Mr Lytle.

It is not as simple, however, as making the information that institutional investors use available to the retail investor. Mr Lytle says: “Retail investors do not want to spend days poring over a 50-page data heavy document; they want information that can be easily assimilated on the best product to implement a particular investment idea.”

Talking to retail investors requires a different approach. “Rather than an emphasis on geeky information like tracking error, retail investors need to know the ETF spread so they can work out the total cost of buying and selling the fund, yet many websites fail to show these spreads,” says Mr Miller.

Adam Laird, head of passive funds at Hargreaves Lansdown, agrees: “Retail investors do not have the ability to negotiate with providers on costs so it’s important to see all the costs of investing up front.”

Equally important is the reporting status of the ETF – if the fund does not have reporting status then any gains risk being treated as income rather than capital gains, adds Mr Miller.

But there are positive signs that retail investors will soon have access to more information. “Third-party companies like Morningstar are starting to provide independent research on these products for retail investors and give individual funds star ratings,” says Mr Laird.

Ben Johnson, director of passive fund research at Morningstar, says: “Over time the appetite for more in-depth analysis of ETFs has only increased, in particular from IFAs.”

Mr Laird expects the research to become more sophisticated over time: “Companies will provide filtering tools to allow investors to see the key features of the product to use in combination with star ratings to determine which of these products is best for them.”

Mr Johnson adds: “As retail investor interest in passive products increases and these investors become more comfortable with these products, there will be a growing demand for research about the best way to implement these ideas and impact these exposures will have on a portfolio.”

It is likely, however, that these tools will continue to be add-on services provided by funds supermarkets, platforms, or existing research companies rather than an independent website.

Anthony Christodoulou, independent ETF consultant, says: “The companies that currently offer in-depth screening and selection of ETFs are institutional brokers or platforms and that’s unlikely to change as it would be difficult to make money from offering that service alone.”

ETF providers are convinced retail investors will demand more research on these products and that demand will be met, as they continue their push into the retail marketplace and the full impact of the RDR is felt, at least in the UK.

Michael Gruener, head of wealth and retail sales for iShares Emea, says: “If you look at the US market, where 50 per cent of the ETFs trades are made by retail investors, they have a range of extremely sophisticated tools at their fingertips.”

Those tools include concrete ETF recommendations, comparing different ETFs, asset allocation advice based on a risk and return profile as well as providing complete price transparency.

Even though the European market is very different to the US, there are reasons to be hopeful that retail investors will soon find it as easy as their US counterparts to find data on an ETF that is the equivalent of a car’s energy efficiency and acceleration.

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