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Rising Exchange rates

ETFs have been overlooked but they can can provide valuable diversification.

The head of distribution for iShares, Jennifer Grancio, asked me recently why exchange-traded funds are pigeonholed as esoteric and complex investments, while unit trusts that simply track indices are seen as the answer to all investors’ prayers. ETFs do not get the coverage that other investments, notably unit trusts and Oeics do, she said, so much so that only 20 per cent of the ETF market is made up of retail investors.

It is the sort of problem the investment trust industry has had to endure for years. The looming April 5 tax deadline tends to focus thoughts on the unit trust industry, with poor old investment trusts banished to the sidelines.

I have been guilty of overlooking investment trusts – although the split-cap scandal scared readers away from anything to do with gearing, irrespective of whether they had crossshareholdings or not. In the past, I have asked IFAs which types of fund make an ideal core investment holding and they have often pointed to a big international generalist trust. But despite this, most IFAs prefer to stick to unit trusts and Oeics, which are easier to explain, better marketed and give them the opportunity to earn a level of commission, no matter how small.

It is understandable why many IFAs will not entertain products that do not earn them commission but this may change – particularly if the fee-based faction of the IFA world expands. ETFs can appeal to investors, particularly those wanting exposure to markets that are difficult to tap into.

ETFs offer a cheap way of gaining exposure to international stockmarkets and are ideal for investors who want to trade regularly. Because they are open-ended, investors do not have the problem of shares trading at discounts or premiums. They do not levy front-end charges, early redemption penalties or exit charges, annual servicing charges are often below 0.5 per cent a year and they do not attract stamp duty.

Unit trusts are priced daily while shares in ETFs are traded like single shares, so prices move throughout the day. They therefore offer an efficient way of achieving immediate exposure to an index or sector as it rises and falls in value.

As the market matures, the choice available to investors will widen, and ETFs are no longer simply about the FTSE100 or All Share indices. Barclays Global Investors, which dominates the UK ETF playing field, has just added three more ETFs will be added to Barclays’ iShare range of funds.

Seven years after iShares entered the market with its first ETF, it is launching funds that give investors access to the current investment hotspots (private equity, property and water), bringing the number of funds in its stable to 48.

The Water iShare will track the S&P Global Water index, providing exposure to 50 companies around the world involved in water-related businesses and infrastructure. The Private Equity iShare will track the S&P Listed Private Equity Index, which consists of 25 leading listed private-equity companies, and the property ETF will mirror the FTSE UK property sector.

It is perhaps unfortunate that private equity and the property vehicles have only just been launched – both sectors have enjoyed a stonking run of late. But British Land is one of many to warn that the UK commercial property market will slow, while there are huge concerns that many private equity deals are overcooked.

But the long-term credentials of such assets remain intact and the ETF market is growing – and growing fast. Last year, the European ETF sector grew by 50 per cent to almost 50bn. It is now expanding more quickly than the ETF market in America, which is already worth a massive $600bn.

In the UK, Barclays’ domination is set to change. Until recently, foreign providers could not avoid stamp duty with their ETF products, but that is no longer the case. This can only accelerate their growth.

Naturally, many IFAs will shun ETFs, not because of commission but because they favour actively managed funds above passive funds. But today, it would seem that investment is all about diversification. The days of a balanced portfolio of cash, bonds, equities and property are fast fading. Soon, most investors will want to have hedge funds, private equity and the new kid on the block – infrastructure – in their portfolio, to keep up with the Joneses. The ETF may be just the job.

Paul Farrow is money editor at the Sunday Telegraph.

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