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Top Baillie Gifford partner warns ETFs are ‘dumb money’

Baillie Gifford partner and fund manager Charles Plowden has condemned exchange traded funds as “dumb money” and warned they are likely to lead to another crash like the one seen in the latest global financial crisis.

The manager of one of Baillie Gifford’s flagship funds, the £1.5bn Monks investment trust, compared index funds with the complex packaged trading instruments which were missold before the crisis 10 years ago.

Speaking at a conference in Edinburgh attended by Money Marketing, Plowden said investors are blindly buying ETFs without knowing what they contain.

He said: “Over the last five years we have seen there are more indices on the American stockmarkets than there are American stocks in the whole US stockmarket.

“The thing an ETF most closely resembles to me is when the industry came out with collateralised debt obligations and all of these abilities to package dodgy mortgages into triple A-rated bonds which were a statistical construct sold to people as a safe investment and no one knew or cared what was in it. And look at how that ended.

“There’s no interest [in what is in an ETF] because things are going to be there for only three months. Some ETFs turn over once a week. They don’t have time to be interested in the companies they are in. We tend to think of these index funds as dumb money, they are non-thinking money.”

Index funds make up around 30 per cent of the US market, a statistic that makes it “troubling” for the likes of Baillie Gifford to justify active management, said Plowden.

However, he argued active managers will be the survivors if ETFs crash, since this will create pricing inefficiency in the market.

He said: “I haven’t spent time to see how ETFs are structured, I am just observing that there is an enormous industry within the finance area and I suspect it is the same investment bankers that came up with CDOs in 2004.

“They’ve found a new bunch of suckers to suck up and they are all from investment banks. It is not contributing to anything to the wider economy.”

Plowden argued index funds are unfairly categorised as investments as ETFs have a built-in ability to buy and sell shares quickly and on a daily basis.

He said: “A definition that we would buy of investing is ‘the careful selection and long-term ownership of value created businesses’. That is what investing is. It’s backing successful businesses and then living off that cashflow and dividends for the next 30 years. So the selection and the time periods are absolutely vital to that.

“Whereas passive investing doesn’t know what’s in the package, and the main appeal of it is that it is cheap to get in and out of the package, which implies that there is going to be a lot of trading in and out, so almost by definition it is trading not investing.”

In May, Baillie Gifford adopted a tiered-based fee system on a number of its largest investment trusts in response to the FCA’s asset management market study. This means as the funds increase in size, fees will decrease.

In the case of Monks’s fund, fees will reduce to 0.33 per cent on assets over £750m, while below this amount annual management fees will remain at 0.45 per cent.

Plowden argued a problem with index trackers is that many ETFs might hold stocks that have performed well in the past but might see more disruptions in the future.

He said those ETFs that follow the US market are more exposed to financial sectors, which are a quarter of the global index, and are being disrupted by financial technology firms.

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Comments

There are 5 comments at the moment, we would love to hear your opinion too.

  1. “I haven’t spent time to see how ETFs are structured, I am just observing that there is an enormous industry within the finance area and I suspect it is the same investment bankers that came up with CDOs in 2004

    Your suspicions are just plain wrong. It is disappointing to hear an investment professional pleading ignorance about ETFs. Can I suggest what’s really going on here is the application of the tactics made famous by Ryan Holiday in many of his books.

    Comments like – “ETFs have a built-in ability to buy and sell shares quickly and on a daily basis” seems way off the mark. Repeat after me, ETFs are boring Index Trackers, by their very design they don’t engage in high turnover.

    I have put a calendar entry in my diary ready for when the next major sell off occurs and look forward to seeing how well the Monk’s performs.

    • It depends on what the ETF relates to Alan. If you are talking about the S&P 500 then yes you are correct. However, Charles is also correct the US/North American ETF market is saturated. On Bloomberg yesterday, an analyst was featuring an ETF that invests in Marijuana related companies, really?

      A lot of active management companies don’t have a leg to stand on when it comes to commenting on passive instruments, but Baille Gifford are a shining beacon with several flagship funds/investment trusts that should be considered by most investors who have a decent time horizon. Their charges are also very reasonable, Scottish Mortgage PLC, being a case in point.

  2. I like Baillie Gifford and what they stand for, but every time I hear see this bloke quoted I want to slap him around with a great big wet fish.

  3. Vanguard are, I believe, Baillie Gifford’s largest client and also the world’s 2nd biggest ETF provider.

    While the point about the proliferation of indices is correct how will the over BG partners feel about Plowden’s comments? Did they agree his key points before the conference?

  4. I just don’t get it. Why risk alienating yourself from potential clients/advisers who generally use passive investments by inferring that they are directing capital in a “dumb” way. Why not embrace it and educate them on how their style (low turnover, high active share, low cost) can complement/differ from a passive strategy. As Peter rightly points out, Vanguard is a partner of Baillie Gifford so I’m not sure what is to be gained from these comments. Passive baiting and scare stories seem to have become the norm from active fund managers. In reality, the majority need to get their own houses in order.

    I’m not sure that Baillie Gifford needs to get involved in this nonsense given their record and willingness to try and change active management for the good.

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