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IN EUROPE, as well as globally, retail and institutional investors have been steadily embracing the use of exchange-traded funds (ETF).
The move to ETFs is being driven by several factors:
1) ETFs offer a toolbox: providing diversified, liquid, transparent and cost-efficient benchmark exposures in a fund structure to a wide array of asset classes and geographies.
2) The recognition that it is difficult to pick individual stocks and bonds which perform better than the benchmark.
3) It is hard to find active funds that consistently beat their benchmarks.
An increasing number of investors are using ETFs to implement tactical exposure to specific markets and asset classes. Investors are using ETFs most commonly to access broad equities, government bonds, precious metals and emerging markets.
A recent Lipper study of actively managed mutual funds in Europe found that 26.7 per cent of equity funds beat their benchmark and only 23.7 per cent of active bond funds beat their benchmark in 2011. 81 per cent of active large cap managers underperformed the S&P 500 benchmark in 2011 according to a recent study by Standard and Poors.
In Europe, typically four out of ten active funds beat their benchmarks. Finding the time and information to select active funds in Europe is made more challenging by the large number of funds to select from – currently around 35,000 funds. Fund turnover is also very significant with typically 3,400 new funds launched and 2,400 closed each year on average over the past 10 years.
The challenge of finding professional managers who consistently beat their benchmark – as measured by the S&P 500 index – delivering alpha by picking individual stocks has not changed much in the past nearly forty years.
Numerous studies have shown that it is hard for professional active investors to consistently beat their benchmark. What’s more, the annual costs associated with investing in active funds is significantly more than investing in an ETF or index fund designed to track the same benchmark.
These higher costs are another important factor accelerating the move to index investing. Since the recent financial crisis, investors have become more aware of the impact these expenses can have on active fund performance. An active fund that delivers returns below the benchmark prior to costs being deducted looks like a faulty choice for a building block, after deducting the typical annual 1.50 per cent expenses for active funds.
An index fund may not offer the potential to outperform a benchmark, but you do know you will get the benchmark minus fees and any tracking error, which should be very small – typically less than 0.50 percentage points for an S&P 500 index fund.
Index mutual funds tend to exist only on well-known indices, while ETFs cover an ever-expanding array of indices and asset classes. ETFs offer a number of benefits over many of the other alternatives: small minimum investment, typically less than £100; liquidity; diversification; low cost; exchange-traded; and real-time access to a wide range of indices and asset classes around the world.
Deborah Fuhr is a partner at ETFGI, an independent research and consultancy firm. She will be speaking on our Listed Products Masterclass on 24 May. To meet our panellists and dozens more trading gurus on 24 May, buy your ticket today: www.cityamactivetrader.com
Alex Houpert will speak about how you can trade listed products that limit your risk
THERE is little doubt that 2011 was a tough year for investors. Record low interest rates meant savings rates were kept at rock bottom, and higher levels of inflation rendered any return virtually worthless in real terms. It was not much better in the equity markets. Between 14 May 2011 and 14 May 2012, the FTSE 100 Index returned an unimpressive – 7.90 per cent and the Eurostoxx 50 Index was down a depressing -23.93 per cent. This just highlights what a bumpy ride many portfolios would have had last year.
HOW CAN LEVERAGE HELP?
Many people would think it mad to even consider leveraging their exposure in such markets, but the truth is that there are several reasons why you might do just that.
Firstly, you can focus on the short and medium-term opportunities that each rise or fall represents. Plus, you’re not actually restricted to just rising markets, you can position yourself for a falling or flat markets too in an ever growing list of single stocks, indices, commodities and currencies. And actually, by gearing up your exposure, you don’t have to commit as much capital as you would if you were buying the underlying asset directly, so it is possible in fact to lower your overall risk.
FIX YOUR RISK WHILE LEVERAGING YOUR RETURNS
And leveraged returns do not have to come at the expense of unlimited risk. Issuers such as ours have a range of fixed risk trading products that enable you to leverage returns in rising, flat or falling markets and without risking more than your initial investment. They are listed on the London Stock Exchange and trade through a stockbroker account in the same way as trading shares. This means that live prices are displayed throughout the trading day and you can buy or sell at any point during the investment term.
There are three main types to consider ranging from simple fixed risk, fixed return directional trading with Super10s, to geared products such as Covered Warrants or Turbos, which allow you to amplify the economic effect of a rising or falling asset price. Each product has a strictly fixed risk profile. Your capital is completely at risk, but you will never lose more than you invest. Interestingly, all three product types can be traded within the umbrella of self-invested personal pensions (Sipp), although not a shares Isa. These products are used extensively across the world with over €380bn traded on the global stock exchanges in 2011.
TURBOS
Turbos are “geared” trading products, which amplify the economic effect of a rise or fall in the price of an underlying index or single stock. Gearing of 10 for example, means that a 1 per cent movement in the underlying asset will result in approximately a 10 per cent change in the value of the Turbo. There are two types of Turbo: Long turbos for rising markets and Short turbos for falling markets. At expiry, typically after one to three months, a turbo will generate a payout based on how far above (long turbo), or below (short turbo) the underlying asset is in relation to a pre-defined strike price. Turbos have a built-in guaranteed knock-out level, which causes the turbo to expire immediately and limits traders downside risk to the initial investment.
COVERED WARRANTS
Covered Warrants are similar to options – allowing traders to benefit from falling, as well as rising markets. They too are geared instruments and returns amplify the movements of the underlying asset – although traders don’t actually take property of the underlying, so are reliant on the solvency of the provider. Like Turbos, at expiry, Covered Warrants generate a payout depending on how far above (call) or below (put) the Strike Price the Underlying asset is. A key difference between covered warrants and Turbos is that Covered Warrants do not have a knock-out level. This makes them suitable for longer trades as you can ride out a short-term move against you as long as there is time until expiry. If the market is against you at this time, your covered warrant expires worthless and your investment is lost, but nothing more.
SUPER 10S
Super10s are designed to provide a simple way of taking a view on either gold or the FTSE 100 over a three-to six month period. As such, a Super10 will generate a fixed payout of £10 per unit at expiry, just as long as your chosen Underlying Asset has never touched a pre-defined Barrier Level. Capital is fully at risk but you cannot lose more than you invest. With Super10s you need to decide whether you expect the underlying to stay high, stay low or stay within a range.
Alex Houpert is head of sales in listed products at Société Générale. Covered Warrants, Turbos and Super10s are issued by Société Générale Acceptance. In the unlikely event that Société Générale Acceptance could not make payments due, you may lose all or part of your investment. These products are not eligible for compensation from the Financial Services Compensation Scheme or any other compensation scheme.
Houpert will be speaking on our Listed Products Masterclass on 24 May.