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Brian Tora: Tread cautiously with ETF innovation

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One of the joys of this business is that you learn something new nearly every day. Last week I was chairing a conference for IFAs at our London office. There was an underlying theme of active versus passive management. I was not entirely surprised to learn that passive funds now account for around 22 per cent of the market.

Yet the underlying message was that passive is really a cop-out and that, while index tracking was useful in some areas, active was still the preferred route.

Music to my ears, really – not that it turned out to be that simple. Active could well include some of the more sophisticated ETFs now available. The terms alpha and beta resonated throughout the morning. And I came across a new ETF provider for the first time that had launched a series of products adding up to some $18bn. They also proved a source of interesting snippets of information. Appropriate, really, as they were called Source.

With the strapline Succeeding Through Innovation stamped across their literature, they  have an interesting range of products that are far from being your vanilla flavour, index-tracking vehicle.

Among the pearls that dripped from their presentation was that the US is poised to join the other two major oil providers, Russia and Saudi Arabia, in generating 10 million barrels per day. 

Apparently they used to enjoy this level of production but it dipped to a mere four million barrels. 

Fracking is allowing them to return to the big league. It served to reinforce the impression that investment remains a dynamic field in which to operate.

Among the other interesting approaches they adopt is to use research into the success – or otherwise – of brokers’ analysts’ recommendations with a view to constructing a portfolio aimed at using only the ideas of those that consistently add value. This research has been conducted by GLG, part of the Man Group, since 2005, so there is plenty of data to utilise. What with this and high frequency trading, it makes you wonder whether computers are now the biggest players in the investment world.

Then there is China as an investment opportunity. According to Source, China accounts for just 5 per cent of global GDP on a strict foreign exchange basis but 11 per cent if you adjust exchange rates for purchasing power parity. How many investors had even 5 per cent of their assets in this market was the question posed. And, yes, they have an exchange traded fund tracking a China index.

ETFs have moved on a pace since the first were launched to provide simple performance replication of major indices. But with greater sophistication and more complex construction comes a need to understand quite how these vehicles operate. My concern is that not all advisers understand any inherent risks, let alone their clients. Improved education – on all sides – strikes me as essential for the future.

Brian Tora is an associate with investment managers JM Finn & Co

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