|
ETFs are transparent open-ended pooled investment
funds which, unlike normal unit trusts or OEICs, are
listed on major stock markets and can be bought
and sold at any time during market hours. They are
sponsored by banks or investment managers, have their
own boards of directors, have their own custodians and
are independently audited. They are subject to the rules,
governance requirements and the other disciplines of
listed companies, many compliant with UCITs III or similar
guidelines. Unlike an Investment Trust, they do not usually
sell at a big discount or premium to the underlying shares
in the portfolio.
The main reason why UK charities have been slow to
grasp this new concept lies in the traditionally narrow
investment management approach to charitable funds.
Investment choices were broadened by the Trustee Act
2000 under the 'general power of investment' and, despite
the fact that studies show that it is asset allocation that is
the key determinant of the level of long-term investment
returns, traditional investment managers have generally
preferred to concentrate on active stock picking.
This has
all too often proved to be a triumph of hope over
experience, with comparatively few active managers able
to "beat the index" and many suffer periods of damaging
underperformance.
An ETFs' defining characteristic is that
they are index-tracking and designed to generate returns
close to those of any given index, such as the FTSE 100
for instance. It is this aspect which makes them so useful
for implementing asset allocation decisions.
Once an
investor has decided on the asset class into which they
would like to invest, it remains only to identify an index
which accurately reflects the price movement of that asset
class. Provided that an ETF has been created to track this
index, the investment can be made rapidly and cheaply.
This simplicity is a great advantage.
The first ETF launched
in the US in 1993 and they have been widely used by
charitable endowments for almost fifteen years. Offering
accurate index-tracking and good liquidity, they give
trustees easy access to a wide range of investment
opportunities which were previously difficult and risky to
access, such as private equity and commodities.
The first
ETF came to the London Stock Exchange as recently as
2000. The trickle of others which followed has turned into
a flood of new and diverse launches which has begun to
transform the UK investment landscape. As of November
2008 there were over 1,500 ETFs in existence worldwide
with combined assets of £465bn offering a well diversified
choice of asset classes.
During the turmoil in markets in
2008, number of ETFs increased by 31%. In Europe, their
popularity and usage continued to rise throughout the year
and net investments into ETFs were £44.3bn during the
first 10 months of 2008, according to Lipper Feri,
compared to outflows of £362.9bn over the period for
mutual funds. Cost efficiency is a crucial advantage for
ETFs.
There are no entry or exit fees and their internal
management fees are reasonable, typically between 0.2%
to 0.85% per annum. An investor can buy into any one of
hundreds of different asset classes with an investment of
just a few pounds and no stamp duty is payable on
secondary market purchases. It is said that ETFs can be
or have been used to manipulate market prices.
Some
ETFs offer stock lending, which is now well-established
and big business. It began as a way of facilitating the
prompt settlement of trades but they are available to many
stock borrowers in order to sell short. While ETFs cannot
be accused of manipulating markets themselves, stock
lending is capable of generating worthwhile revenues,
reducing the ETF management fee, though it should be
noted that it introduces an element of counterparty risk.
Some trustees question whether ETFs are the latest
new, risky type of investment, a bit like hedge funds were
ten years ago. They are hard to compare as they differ in
so many ways.
The key factors which lead investors to
perceive hedge funds as high risk investments were
gearing, lack of transparency, lack of liquidity and lack of
regulation. None of these shortcomings apply to most
ETFs. They mostly contain no gearing and reflect the
performance of an index whose underlying composition is
a matter of public record. Not all ETFs are exactly the
same and are issued by a range of counterparties, so
investors should always take professional advice before
buying. ETFs are a low risk investment for charity trustees.
They offer inexpensive access to a full range of asset
classes, give daily liquidity and trade just like ordinary
shares. They allow trustees and their advisers to
concentrate on the big decisions that matter to
performance. Should you be in equities? How much cash
should you have? Once you have decided, ETFs are
currently the cheapest and easiest way of buying what you
want to invest in.
Top
|
