Private investors are increasingly choosing low-cost index trackers over more expensive “actively” managed funds – leading the providers of exchange traded funds (ETFs) to predict that the future of fund investing will be “passive”.
Recent figures show that in 2008, while the MSCI World Index was plunging 40.1 per cent, investor behaviour was changing. Assets held in European ETFs increased 11 per cent on the 2007 level, to $142.6bn, according to Barclays Global Investors. By contrast, assets under management in conventional UK funds fell 22.9 per cent to £360.7bn, according to the Investment Management Association.
Managed funds still outsold index tracker ETFs in the first half of this year: by $60.2bn to $15.2bn, based on Lipper’s data. But the fact that one fifth of inflows are now into passively-managed trackers is seen as evidence of a shift away from the conventional wisdom. More investors appear to believe that the certainty of a return in line with an index, or “beta”, is preferable to the chance of a market-beating return, or “alpha”, from an active fund manager.
“September was critical for ETFs last year,” says Hector McNeil, managing partner at ETF Securities. “From an investor’s point of view, you saw that most managed funds weren’t delivering alpha. It made investors realise that the majority of managers’ funds are really just ‘beta-plus’. There has been a massive shift to ETFs.”
Brokers also report rising volumes of ETF trades. Barclays Stockbrokers says the number of clients trading ETFs has risen 220 per cent since the first quarter of 2007, with the number of purchases up 287 per cent.
As they are listed funds, ETFs can be bought through execution-only brokers at low cost, with no stamp duty payable, and with only minimal annual management charges.
“They are better value in that their total expense ratio – or TER – is lower than managed funds’,” says Sheridan Admans, investment adviser at The Share Centre.
“They offer much more liquidity, too. With an ETF, you can trade it throughout the trading day. With a managed fund, you can only buy and sell at lunchtime and the trade doesn’t settle until three or four days later.”
Some conventional index tracker funds carry even lower TERs than listed ETFs. Vanguard’s UK Equity index tracker, for example, has a TER of 0.15 per cent compared with the typical 0.3 per cent TER on a FTSE 100 ETF. However, these funds do not offer the same tradeability. “Even though Vanguard make things cheap for you, it’s not much use if can’t get in and out,” argues McNeil.
ETFs’ liquidity saw the total value traded on the London Stock Exchange – where 216 ETFs are now listed – increase 67 per cent in 2008 to £34.7bn. In the financial year to date, ETF trades are up 28 per cent on last year. Financial advisers believe a greater understanding of how low charges can enhance fund performance is driving this growth.
Research by Bloomsbury Financial Planning shows that a FTSE All-Share tracker ETF with a TER of 0.35 per cent would turn a £10,000 lump sum investment into £30,416 after 25 years, assuming a gross annual return of 5 per cent. Some actively-managed funds with TERs above 1.6 per cent would manage less than £20,000.
“Cost is an issue,” admits Admans. “The higher the cost of paying for an active manager, the more performance a manager needs to cover those costs.”
