Vestra Wealth’s Mario De Bergolis (pictured) talks about where he sees opportunities for using exchange traded funds (ETFs), and underlines the dangers of counterparty risk.
What role do ETFs play in your investment process?
We tend to use active funds and listed securities as the core part of a client’s portfolio. ETFs will sometimes be used as satellite positions around these core investments. They are a useful means of obtaining low-cost, tight tracking exposure in order to over or underweight certain sectors based on a short-term outlook.
In addition, we use ETFs for asset classes where we deem alpha generation potential to be limited due to more efficient markets – rates, for example. Also, we tend to use ETFs for physical commodities where we like to invest in the commodity in its purest sense while mitigating any risks inherent in other commodity proxy investments.
How do you use ETFs? To buy and hold, or for trading?
Our investment horizon for ETFs tends to be more short-term than that of active funds; months rather than years. In today’s macro and geopolitical environment, ETFs provide a nimble and efficient vehicle to implement tactical asset allocation decisions and increase or reduce market exposure quickly.
What ETFs have you used recently?
Gold ETFs have been popular for some time now and, to a lesser extent for collective portfolios, gilts and developed market large cap equity funds.
Do you think there are any major issues hindering the ETF market?
Even though growth in the European ETF market has been huge in recent years, it still suffers from lower trading volumes, smaller product sizes and higher fees compared to its US counterparts.
To some extent, this is due to the ‘buy and hold’ mentality among European ETF investors, which is no bad thing, but it does have an impact on the liquidity of the products available.
Are you concerned by counterparty risk? Is it more of a problem with ETFs than other active funds?
Counterparty risk is always a concern and is more of a problem with ETFs, particularly if the product is swap-based. As has been widely reported, an investment in synthetic ETFs requires transparency regarding counterparty exposure and the quality of collateral provided.
However, it is also important to examine the securities lending policy of providers with physically-backed products, as the investor is exposed to the lending counterparties.
What is the quality of collateral and is it ring-fenced internally? Is it overcollateralised, for example?
Are there any ETFs you would not use?
We would not use any inverse or leveraged ETFs, as spikes in volatility can be potentially damaging and can cause losses.
Most of these products reset daily and performance over longer periods of time can differ significantly from the performance of the benchmark. These products are more suited to investors with a day trading profile, which is not representative of our typical client.
Also, we do not like using swap-based ETFs, preferring to use physically-backed ones where possible.
Are there any asset classes where ETFs are more efficient than others?
ETFs tend to be more efficient in markets where it is difficult to pick equities or bonds that will consistently perform better than the benchmark.
When the alpha of a strategy of an active manager does not compensate for the fee charged, then ETFs are a sensible alternative. Developed equity index funds are such an example. Conversely, at present it is difficult to find any effective ETFs on real assets, such as property.
Do you prefer ETFs to traditional index trackers?
We have no real preference between ETFs and traditional index trackers as long as the vehicle has a robust structure and an efficient replication methodology.
It comes down to cost and liquidity. If intra-day liquidity is of great importance, then ETFs will always be the preferred option.
Do you ever use structured products? What types are you looking for? If you don’t use them, why?
We are aware of structured products and their value in client portfolios as a beta capture tool, while maintaining attractive risk asymmetry. However, at present we haven’t included them as part of a client’s asset allocation purely because we favour simpler structures without the need for derivatives.