There’s a continuing debate in the advisory sector regarding the use of ETFs rather than Index funds. The latter has seen an explosion in their use in the UK over the past few years. It’s been led to some extent by the professional financial planning community taking a keen interest in managing the cost of investing, focusing on the benefits of planning and taking a disciplined approach to delivering a low cost investment experience for the client.
We’re not here to argue for an Active or Passive approach. What we are interested in is low cost investing, that is, for any asset class or type of stock, providing a platform that ensures that transaction costs are kept to a minimum. This does then lead on to a debate between ETFs and Index funds.
ETFs have grown significantly in popularity, more so in the US than this side of the pond. In the US they provide the foundations for many client portfolios but here in the UK they are only more recently being considered a mainstream investment vehicle.
Why this growth? One of the key drivers is cost. According to Just ETF, management fees are around 0.05 to 0.5%, a range that seems to be on average 2-10 basis points lower than index funds.
Where costs are concerned a potential downside is that ETFs have a bid/offer spread. However, this is often negated by the overall cost of investing where the client is holding assets over the longer term, but will play a more influential part in determining the impact of costs on portfolio returns if the ETFs are being traded on a frequent basis. ETF costs tend to be more transparent, with OEICs having higher TERs due to management fees.
Traded like individual stocks, ETFs can be more flexible, giving clients access to markets and sectors not available through passive funds. There has been more development in the ETF index space, such as now being able to invest at low cost in such diverse sectors as nuclear energy.
This flexibility extends to trading frequency and timing as ETFs are priced throughout the day, whereas index funds are priced only closing and can only be traded on the last close price. In turn, trading of ETFs can create challenges for platforms where ETFs buy and sell at high price points. Platforms need to be able to trade fractions of ETFs, ensuring clients are fully invested or dis-invested.
In the US, ETFs are now the mainstream investing vehicle for advisers and planners in building client portfolios. So why isn’t this the case in the UK? An interesting Morningstar debate here, which lays some of the blame at the door of platform providers. We can’t argue with this, self interest has always been a driver of influence. We think it’s time platforms focused on innovation aligned to the needs of clients and advisers. It’s time to do things differently.