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UK equity ETFs ripe to be revisited

The resurgence of the UK has been well documented this year, the UK economy continues to grow and consumer confidence is at a 13-year high. These factors are feeding into the UK stockmarket. Many of the major indices have hit all-time highs, particularly the FTSE 100 which has broken the 7,000 mark.

UK equity is an important sector for passive investors; currently more than 50 ETFs manage in excess of £10bn. Looking beyond the election to a new set of opportunities, it seems an ideal time to review the options in UK equity ETFs.

The most important index for ETF investors is the FTSE 100, the UK’s headline index of blue chip companies. Though the FTSE 100 is sometimes criticised for its narrow representation of listed British companies, it has two main appeals. First the income potential – the FTSE 100 has yielded between 3 per cent and 3.5 per cent for most of the last decade. Second is its liquidity, it is a top index for investors who need flexibility to buy or sell.

Eight ETF issuers offer FTSE 100 tracking ETFs, the largest is the iShares Core FTSE 100 UCITS ETF. This is the UK’s oldest ETF, listed 15 years ago as “iFTSE 100” on 27April 2000. Through its size and prominence, it has become one of the most liquid ETFs with a bid ask spread often below 0.05 per cent. In late March, iShares cut the ongoing charge on the ETF to just 0.07 per cent – a move that saved investors around £12m in fees annually. This is a top quality ETF for low cost UK equity.

The second largest is Vanguard FTSE 100 Ucits ETF. It has an ongoing charge of 0.09 per cent and a bid-ask spread of around 0.05 per cent to 0.15 per cent, which makes it a solid option. A final mention goes to db X-Trackers FTSE 100 Ucits ETF, which reinvests dividends rather than distributing them. It is a worthy competitor with an ongoing charge of 0.09 per cent and typical spread of 0.15 per cent to 0.2 per cent.

Smaller companies

Many portfolios additionally hold smaller companies and my top index is the FTSE 250. These ETFs have produced better returns than other major UK indices over the last 15 years, even after accounting for their higher risk. The index is more diverse than the FTSE 100 and includes more than 40 investment trusts.

The most liquid of the seven ETFs is the iShares FTSE 250 Ucits ETF (MIDD), though its annual charge of 0.4 per cent is the highest in the group. A long-term investor might prefer the younger Vanguard FTSE 250 UCITS ETF, as its annual charge of 0.1 per cent per annum is by far the cheapest. For an all-rounder, consider HSBC FTSE 250 ETF with an annual fee of 0.35 per cent and spread typically of 0.15 per cent to 0.3 per cent.

No ETF truly covers UK small or micro-cap companies, as poor liquidity in these companies makes it difficult to invest passively. But one product reminds me of the importance of checking the index your ETF tracks. The iShares MSCI UK Small Cap Ucits ETF gives some exposure to smaller companies, but 80 per cent of its portfolio is invested in FTSE 250 stocks and it includes 5 FTSE 100 firms. Few investors expect this from a small cap investment.

Smart beta

Smart beta ETFs are becoming ever more popular for individuals’ portfolios, particularly for UK equity. The first, iShares UK Dividend Ucits ETF, was listed in 2005 and has raised more than £750m. The FTSE UK Dividend+ index has been a popular strategy, but investors should be cautious – the index contains just 50 stocks chosen and weighted by yield, making it ultra-vulnerable to dividend cuts. The index suffered in 2008 when it was heavily skewed towards financial stocks.

The SPDR S&P UK Dividend Aristocrats Ucits ETF was built to focus on income quality, selecting only stocks with a 10-year record of growing dividends. Its yield (currently over 4 per cent) and ongoing charge of 0.3 per cent make it attractive for an income portfolio. But beware, this 30-stock portfolio is very concentrated and the strategy underperformed through most of 2014.

Two ETFs choose and weight companies on fundamentals. Recently the PowerShares FTSE RAFI UK 100 ETF has been uninspiring, though its value seeking methodology has been successful in other markets. First Trust United Kingdom AlphaDex Ucits ETF uses an in-house formula to choose growth and value stocks. It has outperformed since launch but its record is relatively short and its ongoing charge of 0.65 per cent is the highest in this space.

Smart beta is an opportunity for UK equity, but I feel the most promising investments lack track record. For now, I will be sticking with market-cap.

Adam Laird 
is head of passive investments at Hargreaves Lansdown

Disclosure: The author holds a long position in HSBC FTSE 250 UCITS ETF.

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