Exchange traded funds: are they an accident waiting to happen?
FT Money Show presenter James Pickford and guests discuss ETFs - one of the biggest investment trends of recent years. They also debate the way we measure inflation and analyse what's happening at Barclays Smart Investor platform.
Presented by James Pickford. Produced by Lucy Warwick-Ching. Edited by Paolo Pascual.
Exchange-traded funds are they an accident waiting to happen? Why the way we measure inflation matters for your money and Barclays direct investing service finds itself in hot water over dividends. Welcome to The Money Show, the FT's weekly podcast on personal finance and investing. I'm James Pickford, deputy editor of FT Money and I'll be giving you this week's money news in downloadable form.
First, one of the biggest investment trends of recent years has been the growth of exchange-traded funds, or ETFs, which allow investors a cheap and convenient way of buying into a particular stock market index or a particular region or commodity or some other kind of investment theme. There's now $4 trillion invested in them around the world, but the very popularity has led to worries that we might be looking at a bubble of some kind. Ian Smith, companies editor at the Investors Chronicle, who is currently on loan to the FT, has been looking into the ETF phenomenon for us this week and is here to explain the latest developments. Ian, thanks very much for joining us.
Thanks for having me.
First, can you give us a quick explain of what are ETFs very briefly and why is it that they've done so well?
This is an investment vehicle that started life in the 1990s. The first exchange-traded fund tracking the S&P 500 in the States was introduced in 1993. The idea was to give investors a diversified exposure to the stock market rather than be exposed to the idiosyncratic risks of any particular company going belly up, you could invest in a fund or buy units in a fund that buys-- takes positions in all the underlying stocks in an index. They were attractive to private investors over and above mutual funds, for example, because they can be priced intraday, so--
So throughout the day.
Yeah, throughout the day. You can get a sense of the price, you could exit them very easily and they can be held via-- for the private investor, a self-invested personal pension, or an ISA, or a share dealing account, so they're quite easy to access, they're cheap. So they've become very popular for people that don't want to stock pick.
That's very clear, so why have they then been seen more as a threat now or by some people?
Lots has been written about ETFs being cheap and how they are an alternative to traditional equity investing or funds or other types of funds, but there is growing concern about the size of this investment vehicle and how it is feeding passively invested money into certain companies. So many of these ETFs track an underlying index like the S&P 500, so they buy the underlying stocks in proportion to their weighting within the index. The problem is when you have lots of net inflows into ETFs and you described how large this asset class-- all this investment vehicle has grown-- is that-- as the FT's John [INAUDIBLE] puts it-- the winners keep on winning and the losers keep losing, in that the companies with the largest market caps attract a lot of inflows, so they get automatic bids just purely because they are larger. So people are worried that this is harming price discovery in the market, that is the market's ability to effectively value companies.
So actively managed investment looks for companies on the basis of value and other metrics and thus, tries to determine the price of an asset whereas a company will get bought by an ETF provider purely because it's a large company within the index. So people are worried that it is feeding a general bubble between-- within equity markets. People are also concerned about the market making process behind ETFs and whether that will go wrong. So we've seen a couple of flash crashes within ETFs and people are slightly concerned that in a time of a big market sell-off in the underlying securities-- that the market making process behind an exchange-traded fund might break down.
So that seems to-- so the automated nature of ETFs skews the market potentially. What are the risks for individual investors in the market?
So it depends what kind of ETF you buy, you can have a physical ETF that is backed by the actual securities, so some people would argue that your risk so limited there because ultimately you have a call on the underlying securities. So you might just end up being handed back some-- well, it depends on how large your investment is-- the underlying securities that you have ownership over in the worst case scenario of a big market sell-off. With synthetic ETFs that are backed by a counterparty agreement between the ETF provider and an investment bank, for example, you need to look at the collateral being held against that swap, for example, because you might be exposed to counterparty risk that is the risk of the bank collapsing and we've seen in recent history that that can happen.
So it depends on the type of structure you access, but also private investors picking up an ETF, they might need to take into account the proportion of concentration risk that they are taking in terms of being invested in those very largest companies. Does the average investor in the S&P 500 ETF really understand how much of their investment is exposed to the very largest companies at a time-- at the moment where equities are really highly valued-- companies really highly valued relative to their earnings? So there's a valuation risk that some people think is being accentuated through ETFs.
And so you've laid it out very clear. Is there any way of avoiding this kind of ETFs bubble for investors? How would you go about and how would you go about safeguarding your investments?
So some people think the answer to this is yet other ETFs.
More ETFs because obviously there's many types and if you go for a smaller cap ETF that hunts for companies that have a smaller market capitalisation-- that you might be up to insulate yourself from some of that valuation bubble that some people have identified. And another thing is to look at those companies or to buy stocks in those companies that don't get picked up by indices, perhaps because they have too much management ownership or because their liquidity isn't high enough in the shares. The problem is then you get into other risks, but there are ways of trying to identify companies that don't get these automatic bids from the big ETF providers.
Thanks very much there to Ian Smith and you can read more about ETFs in our cover feature this week online and in the FT Money section this weekend. Now, cast your mind back to 2015 and you may remember inflation hovering around 0% and economists talking about the risks of deflation, it seems a very long time ago. In August the UK consumer prices index reached a five-year high, climbing to 2.9%-- driven by higher clothing prices and the reverberations of the fall in sterling following last year's Brexit vote, but the CPI index is only one of the ways in which we measure inflation, as Lindsay Cook our Money Mentor explains in her column this week. Lizzie, thanks for coming in.
Rising inflation simply means the prices of the goods and services we use are going up. Why does the way we measure it make any differences to our finances?
Well, for many years we had the good old retail prices index, it had a basket of goods and then CPI was invented and now we have something called CPIH and it means it's all very confusing. And from my seat it looks like when the government is paying we use the lower calculator the CPI, when we're paying things like student loan costs or railway, we use RPI, which is approximately 1% higher.
And why is there that difference between CPI and RPI?
Well, CPI is calculated in a different way. First of all, it doesn't have any owner-occupier housing costs included and for most of us who've got mortgages or pay council tax and things like that, we think, hang on that's quite a big part of our income--
--and they also have this funny way of calculating things-- their basket of goods, the weighting of items is changed. So if land goes up in price, they say, oh, well, people buy less land, so the shopping basket-- we won't buy the things and there is a sense in that, but it also means they make it work how they want it to is how I see it.
Is RPI always higher than CPI or, what, does it change?
It does change, but recently there's been about a 1% differential as when we had no inflation-- RPI-- and when interest rates were falling RPI was below CPI. Now, we may have interest rates rising, we also have inflation, CPI is below by about 1%.
So what-- you mentioned student loans, are the interest rates going up on those?
They have already gone up. They are fixed according to the RPI in March and that was 3.1%, so they're now paying interest at 3.1% plus 3%, which is the calculator. And rail, it goes up according to the RPI in July. It take a different month-- a different thing is [INAUDIBLE] and so that means regulated rail fares will go up by an average of 3.6% in January. Now those are the regulated fares, the leisure journeys and the first class travel, et cetera, that's up to the rail companies how much they charge us. Last year when the average was 1.9% with all the fares, it went up 2.3%. So you can expect that the fares will go up a bit more than 3.6% come January.
So it's curious because the ONS, I think, has said it's not happy with RPI, with the retail price index, but people still continue to use it.
Well, they have to because there are things like indexing [? gilts ?] and some of those will go up 50 years to run. They're other commercial contracts, which have RPI in them and so they have to be there. What I don't understand is why when back in 1996 and people said, RPI isn't working properly for us anymore, it doesn't cover an average of what people spend, they didn't say, oh, let's fix RPI because the basket changes every year or do a consultation and say, we want to put this into RPI or take it out of, but no, they said, oh, let's have another one--
--we like this one better. And now from March-- although it's not used for any pricing-- the CPIH, which does include an element of owner-occupied housing costs in that they do a calculation of what the average rent would be for that house and you just own property and you just think, well, no, what about an average mortgage interest payment or something like that.
Which moves up and down during the year.
Well, talking about interest rates, I mean, the big question is, what will happen to them if we do get a rate rise-- Bank of England-- from the Bank of England that we've-- many people expect in the next coming months? How might that affect these inflation rates?
RPI would go up, but CPI wouldn't neither would CPIH. So they're the lead rates, they're the ones that are regarded as technically OK.
And they would-- they wouldn't go up because they don't include--
They don't include interest rates, they don't include credit card interest rates and quite a few people have credit cards nowadays.
Thanks very much there to Lindsay Cook. You can read more about inflation's impact on your wallet online and in the FT Money section this weekend. Barclays DIY investment platform has been in the news recently for all the wrong reasons. This online stockbroking service has been struggling with technical problems and investors on the platform have been waiting for weeks in some cases for certain dividends to arrive. These are shares in some of the FTSE's biggest income stocks. Kate Beioley, a reporter at Investors Chronicle, has been covering this story for the FT and is here to tell us about it. Kate, can you explain for us what Barclay was trying to do and what went wrong?
Yeah, so the issues all stem from Barclays overhauling its stockbroking platform and moving to this new site, Barclays Smart Investor and so there've been quite a few of glitches with that process, and most recently the platform's been struggling to pay a raft of dividends on time. Some people have been logging into the site waiting to see their dividend payments come through and they've been waiting up to two weeks for some of the worst affected ones. Some of those include Shell, BP, Seagram, Imperial Brands, among others.
Right, so you said some of these stocks that are affected have some of them now been paid and others are still waiting. What's the--
Yes, so the issue affects all stock-- well, not all stocks-- the issue affects stocks that went ex-dividend before the platform switch over on the 28th, but had payment dates after that. So there are hundreds of potentially affected stocks there and in fact Barclays says only 4% of the equities on this platform fall within that bracket and delays have varied from three days to two weeks of them include BP, for example, dividend was due on the 22nd of September and only paid last Friday. Shell was also paid nine days late. To add insult to injury, Shell investors received the wrong amount when they were paid, but, yes, so other affected stocks have also been paid now and there are a few outstanding.
So there are a few, I mean, a few outstanding. Do you know when we can finally close a chapter on this?
Yeah, Barclays says, the 12th of October is the final date when everyone should have been paid and hopefully before then for many of those outstanding.
So if I've invested in this platform and I'm expecting my dividends and I had a delay and I've suffered from it, what can I do? How can I complain about it? Well,
The financial ombudsman does pay compensation where customers have been financially harmed, but that process is not quick and to apply to them you first have to show you've tried to resolve the issue with Barclays. You have to give them eight weeks to give you a final response, so basically there the key thing is to complain first to Barclays and then if they really don't resolve your issue then take it to the [INAUDIBLE].
And what kind of response has Barclays been giving to people who complained to [INAUDIBLE]-- if anyone asked for and got compensation?
Yes, it has been compensating people, it's not giving compensation as standard some readers are saying they've been given between 100 to 200 pounds compensation. Barclays itself says it's judging everything on a case by case basis and says that anyone affected should be complaining to them first.
Thank you, that was Kate Beioley of the Investor's Chronicle. That's all from The Money Show this week. If you got a story you'd like the FT Money team to follow up or a question to pose to our team of financial experts, get in touch, email us at Money@FT.com, tweet us at @FTMoney, or comment on our articles online at FT.com/Money. We'll be back next Thursday at the usual time. Goodbye.