ETFs: a cost-efficient way to access markets?

0
Written by: Tom Bartolacci
30/01/2017
Exchange-traded funds (ETFs) have been around for years, but they haven’t yet achieved mainstream appeal in the UK. Given their simplicity, we believe it’s only a matter of time before self-directed investors embrace ETFs as a core investing solution.

More similar than different

So, what are ETFs and how are they different from “traditional” funds such as unit trusts and OEICs? The first thing to say is that there are more similarities with traditional funds than differences. For example, ETFs pool the money from many like-minded investors and give that money to a professional manager to invest it in markets, using scale to achieve cost-efficiency.

The majority of ETFs available in the UK are UCITS products, which means they are governed by the same regulations and have similar investor protection frameworks to unit trusts and OEICs. Like traditional funds, your ETF investments are ring-fenced from the balance sheet of the fund company, so it’s safeguarded in the event of the fund manager becoming insolvent.

Most ETFs are passive

You can invest in equities, bonds or a variety of other asset classes through an ETF. There are ETFs that invest actively (that is, they try to outperform a given market or benchmark), but the majority of ETFs are index or passive products, designed to track the performance of an index rather than trying to beat it. That’s a subtle difference compared to traditional funds, where both approaches are available but the majority of funds are actively managed.

Passive investing brings lower charges, because of the lower research costs involved in tracking an index. As a result, ETFs tend to have lower ongoing charges than traditional funds. Passive products also typically have a narrower dispersion of returns around the index than active funds, which is helpful from a risk-control perspective.

Trading places

The biggest difference between ETFs and traditional funds is how they trade. Unlike traditional funds, ETFs are listed on a stock exchange and they are priced throughout the day. This means that you can buy and sell during the trading day in real time rather than having to wait for the next valuation point, as you do with a unit trust or OEIC.

It also means you’ll need a stock broker to access ETFs, and this difference is probably the main reason why ETFs are yet to achieve mainstream appeal. The larger fund platforms are now offering brokerage services, which should broaden ETF access for retail investors. It’s wise to check the cost of dealing, because if brokerage fees are high, that could outweigh the cost advantage from ETFs’ lower ongoing charges.

What to look out for

There are a lot of ETFs out there. Every day, more and more ETFs are being launched that offer access to niche areas of a market or asset classes, like Asian real estate or gold mining companies. With all the choice on offer, it may be tempting to chase the newest “hot” product or investment trend. These may even have a place in some portfolios. However, most investors are best served by low-cost, broad-based, and well-diversified investments, like stocks and bonds.

Also, just because you can trade easily with ETFs, doesn’t mean you should. We believe most investors should not use ETFs to speculate, or trade frequently. Indeed, our research with actual shareholder transaction data shows most people use ETFs in a prudent, buy-and-hold manner.

A useful tool

ETFs are more established in the US than they are in the UK, and the pattern of adoption there gives us some clues about how the market might develop here. In the US, institutional investors were the early adopters because they recognised that ETFs were a great way of achieving easy, low-cost access to markets. Wealth managers and financial advisers came next, followed by the retail investor as market access improved and investors became more comfortable with their structure.

We expect the UK market to follow a similar trend. Institutions and wealth managers are already significant buyers of ETFs; we are seeing increasing adoption by financial advisers; and forward-thinking self-directed investors are buying in growing volume. As access to ETFs continues to grow, we expect them to become well-established as a core portfolio building tool.

Tom Bartolacci is head of capital markets at Vanguard Asset Management

There are 0 Comment(s)

If you wish to comment without signing in, click your cursor in the top box and tick the 'Sign in as a guest' box at the bottom.

Are you a first-time buyer looking for a mortgage?

Look no further, get the help you need by searching for your perfect mortgage

Which ISA is right for you? A round up of the six products available in 2017

From cash to innovative finance to lifetime, here's our guide to the ISA products available to savers this yea...

Guide to buy-to-let tax changes

In late 2015, former Chancellor George Osborne announced a range of  tax measures aimed at landlords, which t...

A guide to switching energy provider

All you need to know about switching from one energy supplier to another.

What will happen if rates change

How your finances will be impacted by a rise in interest rates.

Regular Savings Calculator

Small regular contributions can build up nicely over time.

Online Savings Calculator

Work out how your online savings can build over time.

Five fund tips for a 0.25% interest rate environment

With interest rates stuck at a record low 0.25% and expectations rates could fall to close to zero, here are ...

Protecting family wealth: 10 tips for cutting inheritance tax

Inheritance tax - sometimes known as 'death tax' - can cause even more heartache for bereaved families. But th...

Travel insurance: Five tips to ensure a successful claim

Ahead of your summer holiday, it’s important to make sure you have the right level of travel cover or you co...

Investing your money

Alliance Trust Plc gives you smart insight into how to invest your money

Money Tips of the Week

Read previous post:
stamp duty
Guide to buy-to-let tax changes

In late 2015, former Chancellor George Osborne announced a range of  tax measures aimed at landlords, which taken together could...

Close