View the article online at http://citywire.co.uk/wealth-manager/article/a589619
How Rathbones is using smart beta
by Emma Dunkley on May 24, 2012 at 14:12
Why can ETFs be seen as efficient vehicles for tapping large markets?
It is important to point out that not all ETFs are efficient vehicles – they would need to display a low tracking error, offer reasonable liquidity and carry a low cost in order to be deemed efficient.
We have seen some ETFs within the fixed income space that are more expensive than active fixed income funds. This to us seems an oxymoron. Naturally, replication is easier and more efficient in larger, more liquid markets, such as large cap equity markets.
Do you have any concerns about using swap-based ETFs, as opposed to physical?
We have a definite preference for physically backed ETFs, where it is logical that an investment solution should have direct exposure to the underlying asset it purports to track – gold being a classic example.
It is more difficult to justify buying a FTSE 100 tracker where the pay-off is delivered through a swap, but the underlying collateral comprises a range of securities across geographies, where performance may be hugely uncorrelated to the index being tracked.
We understand that swap-based ETFs might be more appropriate for situations where it is not possible to physically replicate an index fully due to liquidity constraints, and physically backed ETFs may display higher tracking errors.
When investing in swap-based ETFs, it is important to ensure we have enough transparency to understand the collateral that is backing the swap, as well as the counterparty risk.
What are your views on securities lending undertaken by index trackers?
Stock-lending is an important part of minimising tracking error. It also helps to subsidise fees, thereby reducing headline total expense ratios. Investors must ensure, however, that the stock-lending process is robust, that stock is lent to creditworthy counterparties, and that the rebate achieved through lending is sufficient to justify the risk.
It is also important that investors are given sufficient transparency to make sound judgement calls on these factors. Securities lending is only appropriate for physically backed products; it is not acceptable to lend out the collateral backing swap-based products.
News sponsored by:
As the UK coalition government strives to rebalance the national economy, so called 'reshoring' looks set to play an increasingly important role in economic recovery.
Today's top headlines
From Nigeria to Pakistan and from Kenya to Kuwait, frontier markets are catching investors' attention as never before.