Active managers look after passive funds

Investors who doubt fund managers’ ability to outperform an index, but who want a manager to take the asset allocation decisions, can make use of managed portfolios of exchange traded funds (ETFs).

A number of services offer active management of a portfolio’s asset allocation and active decisions on investment timing – but implemented using passively-managed index tracker funds.

Seven Investment Management’s Asset Allocated Passives are portfolios that adopt similar asset allocations to the rest of the group’s funds – except that they hold only ETFs. This is partly because listed ETFs can offer exposure to a range of asset classes with better liquidity, but also because they come at a lower cost. Other tracker funds are used if ETFs are not available in certain sectors or asset classes.

“We think the asset-
allocated passive funds are a cost-effective way of putting together a portfolio of ETF investments,” says Tom Sheriden, chief executive of Seven Investment Management. “The funds don’t have to pay for active fund managers so the savings flow to the customer.”

Most ETFs have a total expense ratio (TER) of between 20 and 60 basis points (0.2-0.6 per cent) a year, and Seven charges another 50 to 75 basis points for deciding the asset allocation. That implies a TER of between 1 per cent and 1.25 per cent for these multi-
asset funds. By comparison, multi-asset unit trusts and open-ended investment companies quote TERs of 1.5 per cent to 2.5 per cent a year.

Private investors could reduce costs further by buying off-the-shelf ETFs and doing their own asset allocation. However, Seven claims that active management is worth paying for.

“The most important thing to get right in a
portfolio is the asset allocation of the fund,” says Sheriden. “We have four
levels of risk and for each
of these we have a fund with its own long-term asset allocation. Every three months, we look at the world and we tilt the holdings in the fund to reflect the view we have.”

For example, the Seven Investment Management Moderately Adventurous portfolio has increased its exposure to UK equities by 3 per cent in the last quarter. This change is also reflected in its AAP Moderately Adventurous fund. Seven achieves this exposure by holding the Lyxor FTSE All Share ETF and a FTSE All Share basket of stocks. To provide the “adventurous” element, it also holds 1.3 per cent in the iShares MSCI Japan ETF and 6.6 per cent in the db x-tracker MSCI emerging markets ETF.

In the UK, this multi-ETF approach has yet to take off. While multi-asset ETF portfolios are common in the US, in the UK the choice is between Seven, Frontier, and Evercore Pan Asset Management.

“This is an area that is growing as the ETF market in the UK expands,” says Christopher Aldous, chief executive at Evercore Pan Asset Management. “It would have been hard to create the asset-allocated passive funds a few years ago because there was not the range of assets available through ETFs that there is now.”

Aldous argues that the growth of ETFs in Europe makes it possible for private investors to gain exposure to assets that would previously have been impractical.

“Substantial sums can be required in order to participate directly in asset classes, such as property, infrastructure and private equity,” he says.

“Management costs can be high, the administration can be complicated and they can be illiquid. Using ETFs solves these problems as they track the indices of the listed companies operating in these fields.”