Shares digital

Current market turbulence creates the kind of conditions in which the liquidity of exchange traded funds comes into its own. Helen Castell rides the storm

February kicked off with a flood of new exchange traded funds in the UK, 11 of them from db x-trackers. Introducing what it says are this country’s first ‘short’ ETFs – allowing you to take advantage of falls in UK and European stock indices – plus funds offering exposure to hard-to-reach markets such as Vietnam and Kazakhstan, db-trackers said it was once again offering ‘first of a kind products’.

But what value do ETFs offer? Are there already too many of them out there? And how can a confused retail investor navigate the seemingly unstoppable tide of new products?

Exchange traded funds, often referred to as tracker shares, are basically index funds traded on the stock exchange as shares. They move in line with the index they track but also offer the liquidity and price transparency that you’d expect from equities.

The flexibility of ETFs is their biggest benefit, says Frank Henze, head of product development at iShares Europe. The wide range of products available means an investor can get exposure to virtually any asset class – or hedge against movements in it.

Most can be invested in Sipps, ISAs or Peps, and – unlike many funds, where prices are computed daily and investors are unable to respond quickly to market movements – ETFs can be bought and sold at any time, he says.

In current volatile markets, where some investors are finding themselves trapped into funds, the liquidity they offer is priceless, says Dan Draper, head of ETFs for the UK, Ireland and Nordic region at Lyxor Asset Management.

Another selling point for ETFs is their relatively low cost, with a typical product priced at just 15 to 70 basis points plus broker commission.

With a traditional tracker fund, retail investors deal directly with the fund provider, which has to manage every subscription and redemption order, explains Manooj Mistry, head of db x-trackers UK, the ETFs arm of Deutsche Bank. With an ETF, investors buy and sell on an exchange, meaning the fund provider does not have to deal with individual investors, and so can keep its costs down.

ETFs also allow investors easy access to obscure or hot markets, such as frontier countries or commodities.

A hybrid of the ETF model is the ETC, or exchange traded commodity, which mirrors movements in commodity indices. ‘ETCs give investors access to markets and asset classes that were previously inaccessible,’ says William Rhind, head of UK sales at ETF Securities, which specialises in ETCs.

Compared with the FTSE 100 – which by mid-February had fallen more than 10% since the start of this year – the firm’s physical platinum, wheat and physical precious petals basket – ETF products were up 25.43%, 24.92% and 16.58% respectively, he says.

The ultimate test of a financial product is of course how much money it will make you – and, used properly, ETFs can be the backbone of your investment strategy, says Draper.

According to Nobel Laureate economist William Sharp, more than 90% of an investor’s long-term returns come from getting the right asset allocation – rather than from clever stock-picking or market timing, he says.

Personal strategy

Draper argues that the best way for investors to achieve their financial goals is with a ‘core-satellite’ strategy, where long-term market-tracking products such as ETFs form the bulk of a portfolio, complemented by smaller holdings in actively managed funds or individual stocks.

Henze agrees. ‘It’s very important that the retail world moves into serious long-term investing with financial goals, rather than taking a ‘play money’ attitude,’ he says. ‘If you look at the experience investors have through stock-picking, it’s very hit-and-miss.’

But while ETFs are ‘a perfect access tool’ for investors who are nervous about stock-picking or non-diversified risk, those who are comfortable with an opportunistic approach can also use them to be ‘a bit more dynamic and still make money in falling markets,’ argues Mistry.

db x-trackers plans to introduce a sterling overnight money-market ETF by the end of this quarter, in which investors will be able to ‘park their cash if they’re worried about markets falling,’ he notes.

The variety of ETFs on offer is of course something that can put investors off. So where to start and why do there need to be so many?

Virtually all brokers now offer ETFs, and while the range of products can seem confusing, to fine-tune your asset allocation this kind of flexibility is key, Draper says.

Finding the right ETF is simple – as soon as you’ve sorted out your asset allocation, he says. ‘It’s based on what you’re trying to achieve – paying your mortgage, buying that great house in Mallorca, putting your kids through school.’

But only once you’ve set those goals, committed yourself to achieving them, and worked out the right asset allocation to get there, he says, you should get on the phone to

your broker.