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Off the beaten track

Investors are increasingly turning to exchange traded funds for simple and inexpensive access to a diverse range of assets and markets from UK firms to global infrastructure projects and soft commodities, says Philip Scott

The expanding market for exchange traded funds has just seen the first issue on the London Stock Exchange of ETFs tracking quantitatively-driven indices.

Spa’s three ETFs join the 18 ETFs issued earlier this month by Deutsche Bank, bringing the total number of ETFs on the exchange to 79.

ETFs track the market in the same way as index funds and, like shares, can be bought and sold during the trading day. The costs are a lot lower than typical funds. For example, the iShares FTSE 100 ETF has an annual charge of just 0.4 per cent and the initial cost is the same as a share trade, around £10. There is no stamp duty.

Spa’s ETFs will track indices from research provider MarketGrader which aim to outperform major US indices by selecting stocks based on analysis of key company fundamentals. Its EFTs are the MarketGrader 40, MarketGrader 100 and MarketGrader 200.

Since the MarketGrader 40 index started in 2003, it has risen by 67.75 per cent to September 7, 2007 compared with 29.63 per cent from the S&P 500 index.

LSE head of product management and development David Shrimpton says the launch “marks a significant development in the UK ETF marketplace. It presents the growing number of investors interested in using ETFs with a new opportunity to outperform major market capitalisation-based indices while retaining the low-cost diversification of a tracker”.

The range of assets and markets that can be invested in continues to expand. The 79 ETFs on the exchange cover a range of UK and global equity and bond indices, as well as indices based on company fundamentals, country and regional indices, company size, dividend yield and sector.

The total value traded in ETFs on the exchange during the first half of this year was £15.6bn – a 79 per cent increase on the value traded in the first six months of 2006.

Deutsche Bank European head of global markets equity Garth Ritchie says: “We see a great opportunity to grow the market for ETFs in the UK. Over the coming months, we plan to provide UK investors with more innovation and choice with ETFs through strategies such as short indices and asset classes such as bonds and commodities.”

The general view is that ETFs are a very useful tool for a fund manager or active private investor because they allow them to reposition portfolios to take advantage of any anomalies they see in a particular index or market.

Seven Investment Management director Justin Urquhart Stewart says: “ETFs provide a fast and efficient entry to a variety of sectors and asset classes at a low cost. Good liquidity levels allow investors to get in and out quickly and not get stuck with cashflow issues.”

There is a downside. ETFs are essentially tracker funds, so no market outperformance is possible.

Paradigm Norton financial planner Carlton Crabbe says: “For the private investor, they are very useful because they are incredibly cheap to buy and sell. There are arguments for investors to take a purely passive approach to investing because it helps keep down costs and they are able to build their own asset allocation. We try to use them as much as possible in our own clients’ portfolios because they keep costs down.”

Crabbe recommends the iShares UK Dividend +. He says: “This tracks high-yielding stocks in the FTSE 350. It currently has a yield of 4 per cent, which is very helpful when reinvested for long-term growth.”

For a more exotic play, there is the iShares FTSE Epra/Nareit Asia property yield fund. “We currently have a tilt to this in our clients’ portfolios because it continues to show potential value compared with UK commercial property,” says Crabbe.

Urquhart Stewart likes the Macquarie global infrastructure 100 fund. Crabbe is also a fan and says: “This tracks infrastructure and gives a nice yield. It gives our clients cheap and easy access to infrastructure projects around the world and is another way to diversify portfolios.”

Urquhart Stewart says: “I also like simple sectors and asset classes – FTSE 100, All Share and S&P 500.”

A growing advantage of ETFs is that they offer a way for advisers and their clients to access commodity markets.

Exchange traded commodities track a range of global markets and industries, and even soft” commodities such as coffee and corn. They are one of the cheapest and most tax-efficient ways into more esoteric assets.

Investors need to be aware when they invest in narrowly focused ETFs or ETCs that they should be prepared for extra volatility.

Urquhart Stewart says: “ETFs can be risky as any investment. If you get your asset class wrong, you will have a problem but you can get out easily and cheaply. Asset allocation is generally thought to be more important than stock or fund selection, thus ETFs allow you to focus on this and not worry about the underlying stocks.”

Commodities can be a very specialist area so advisers and their clients need to know what they are getting themselves into. Whitechurch Securities investment director Gavin Haynes says: “They are still low-cost routes into pre-determined specialist areas. They definitely have their role to play.”


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