What type of beta products do you use and why?
We use primarily index-tracking products and these are mostly iShares exchange traded funds (ETFs). We have chosen to gain broad beta exposure rather than specific access to niche segments, so we own, for example, an ETF on the MSCI World rather than something at a sector level.
In 2009, when we decided to increase exposure to markets, we bought the iShares FTSE 100 as this was a broad and efficient way to gain access.
Why are ETFs efficient vehicles for tapping large markets?
It’s mostly because of the ease of transition. Unlike a unit trust, we can just trade into an ETF during the day, and someone can buy one share of a FTSE 100 ETF for as little as around £7. Most index funds, such as iShares, also lend out stock, which can lower the total expense ratio.
The tough thing on the active management side is that over a three-year period, only 3%
of active managers beat their index. So if we think the market is going to rally, and if we
buy the index, we will participate in this rise, whereas 97% of the time, the active manager will underperform.
We tend to buy alpha when we think there’s no beta to be had, so we buy the likes of Giles Hargreave, for example.
Are there any asset classes where you think beta products are inefficient, such as fixed income?
We own a small amount of a fixed income index. Fixed income ETFs originally were structured to give most weight to the largest issuers of debt, which meant you were buying what you don’t really want to buy – the aim is to lend to the richest people who can pay you back.
ETF providers have been good at restructuring indices so they can represent a balanced view of the fixed income markets, whereas five years ago, these indices were clumsy.
Also, index providers have been slicing fixed income into specific segments, such as high yield and corporate bonds, increasing the range of options available and providing a good alternative to active funds.
We use the iShares Markit iBoxx £ Corporate Bond ETF, which mirrors a long-dated corporate bond index. This gives us easy access to that index, which is the benchmark that most active corporate bond funds are trying to beat.
That means you can own this at a very low cost, whereas you might not be able to own Richard Woolnough’s M&G Corporate Bond fund as cheaply.
We also own a less volatile ETF, which is based on a shorter-dated corporate bond index. These two funds provide a very real way for clients of any size to own a basket that will give them that return and it’s important because they’re cheap and they’re large, while offering decent dividends.
What about using active ETFs to help manage exposure to the underlying asset, or is this concept an oxymoron?
Aren’t active ETFs just an active fund? People are adding the word ETF to their products. They’re not bad, but it’s just like buying an active fund. It is listed and it is open-ended, so if it’s more convenient on a mechanical basis, then fine. But active ETFs are an oxymoron.
Do you have any concerns with using swap-based ETFs as opposed to physical?
People have made a fuss over nothing. In many cases, it’s a more efficient and more economical way of doing what the client wants. There are certain sections of the market where it is difficult to replicate the index. But are you worried the swap might fail? None have failed so far, and the swaps are cheap and more efficient.
But if you buy the MSCI World or S&P 500, you don’t need swap-based exposure because these markets are so efficient. If you want a smaller companies index to replicate, though, then it may be cheaper to own a swap-based fund.
What are your views of securities lending undertaken by index trackers?
Securities lending is a fantastic thing. If you own a pool of assets and people will pay you rent for these stocks that would otherwise just sit there, then this is a good way of reducing your overall total cost of ownership. So if you own an ETF and iShares, for example, lends out the underlying stock, this is a really good outcome, although it’s something that many people do not understand.