Private bankers join ETF revolution

The range of exchange traded funds (ETFs) available to investors has considerably grown in the past few years and so have the ways they can be used in clients’ portfolios. According to Veronika Schaschenmayr-Schlick, portfolio engineer at Pictet Wealth Management, private investors are finally becoming comfortable with, and seeing the benefit of, using ETFs. “This is mainly because increased volatility is driving asset allocators to do much more tactical asset allocation to gain exposure to markets,” she says. Also, says Ms Schaschenmayr-Schlick, ETFs allow clients to avoid specific risk, such as that of investing in a manager who may underperform over a short period of time, but still be invested in the region or sector they are bullish on. “The liquidity and the choice you have within the ETFs have increased quite a lot. There are more and more sector and regional indices, so you can fine tune much better today a tactical asset allocation through ETFs than five or ten years ago.” At Pictet, ETFs are mainly used on the equity side, marginally on the bond side and just occasionally on the commodity side. “We generally use ETFs that replicate broad regions, and also for more specific themes, for example on some tiny Asian markets or the mining or resources sector or Latam equities,” she says. RBC Wealth Management uses ETFs particularly in the strategic part of a client’s portfolio, says head of advisory Phil Cutts. Increasingly, opportunistic investments constitute the non-traditional part of the portfolio at the Canadian bank. This is where ETFs are mostly employed, says Mr Cutts. “We look for niche investment opportunities, which tend to be short-term, and ETFs are an easy way to get exposure to investments that we want to do on a selective basis,” he says. In recent times, RBC has been bullish on gold and recommended investing in gold ETFs as a really easy way to gain exposure to it. “At the moment we feel bearish on government bonds and you can get an ETF that does short government bonds,” he says. As interest rates, currently very low, are expected to rise, they are going to push prices of government bonds down. “If you don’t want to be in equities, you can short bonds and you really have an opportunity at this point in time,” says Mr Cutts. Widening access These types of ETFs have managed to bring down to the retail and high net worth market those types of products and services previously only available to very large institutional customers. “These are institutional type of investments made available in very small ticket sizes at very affordable prices. What you can do with ETFs is greater than most mutual funds. Not many regulated funds can short things, for example,” he says. Levered ETFs have also gained ground. These allow clients to gain magnified exposure to their preferred asset class, with agriculture or commodities being popular recent bets. As the ETF market becomes relatively more complex, advising investors on the best ETFs, as well as asset allocation, becomes crucial. Market liquidity has traditionally been very important, as it assures there is a market out there which is going to give investors a price close to the net asset value, when they want to sell. But today, particularly in more esoteric or niche types of investments, it is important to look at how ETFs are structured, at the swap counterparty, what they are doing with the collateral in case of synthetic replication, and what interest they are charging on the leverage, says Mr Cutts. ETFs have also entered into the world of fund selectors. Yves Robert-Charrue, head of funds and product management at Bank Julius Baer explains that just recently they have started to recommend ETFs to advisers. “The ETF business had grown so much due to client demand and we started recommending ETFs from the product side because there was no systematic approach to ETF selection before.” A whole range of education activities around these instruments is also being carried out, he says. “The idea is that for every category and every asset class we recommend several active funds plus at least one ETF,” he says explaining that his bank has selected 90 ETFs for Swiss clients. “These products that we recommend are for core, long-only investments, and are used both in strategic and tactical asset allocation. At the beginning of next year we will also start recommending leveraged ETFs and inverse ETFs,” says Mr Robert-Charrue. “We will wait until we have a better offering and also, we don’t want clients to invest in products they do not really understand.” Alternative investments Increasingly, alternative asset classes like hedge funds can be replicated through an ETF and are attracting client attention. “I would not say that ETF hedge funds are replicating an industry, but they are giving access to a range of managers which are on that specific managed account platform; it is a proxy,” confirms Mr Robert-Charrue. “The ETF hedge fund is mainly about liquidity, it is easy to buy, but you will never get a performance as good as you would get from a fund of funds.” But Ms Schaschenmayr-Schlick at Pictet, says that when you buy a hedge fund ETF, you are automatically subjected to the provider’s hedge fund selection. “As at today we prefer to rely on our internal hedge fund selection capability,” she says. The biggest ETF hedge fund in Europe is the one launched by db x-trackers at Deutsche Bank, which is the fastest growing ETF provider in Europe with €23bn in assets. An ETF hedge fund overcomes all the typical problems of a hedge fund, such as lack of transparency, liquidity, a high minimum size and lock-up periods, says Thorsten Michalik, global head at db x-trackers. Db x-trackers’ hedge fund ETF, which replicates the db hedge fund index, has already gathered €600m. The index combines five different strategies, which include single managed hedge funds selected by Deutsche Bank for its hedge fund managed platform developed seven years ago. To the end of September, the db ETF hedge fund index returned 9.2 per cent – after all costs with the exception of the management fee of 90 basis points – and has an annualised volatility of just 3.2 per cent, says Mr Michalik. The provider, which offers the broadest coverage of asset classes in ETFs, also has three commodity funds. One is built on a db proprietary index, which has an optimised mechanism enabling it to outperform all the standard indices in the world. The firm also applied this optimised mechanism, and launched ETFs on them – to the Goldman Sachs and Dow Jones UBS indices. This optimised mechanism has generated an outperformance of respectively, 6 per cent and 8 per cent per year during the past 9 years, compared to the standard version of the two indices. With a similar mechanism, the db currency returns index is the result of balancing of different strategies (carry, valuation and momentum) which since 1990 has delivered average annual returns of 8 per cent, without ever having one year with negative performance. Swap based ETFs mirror this profile, says Mr Michalik. “These products may not generate 20 per cent returns, but deliver 5-10 per cent performance and have low volatility, and even more importantly are not correlated to other asset classes,” he says. “Forget that ETFs are just equity and fixed income. In the next few years the majority of ETF assets will go into new asset classes like commodities, currencies, hedge funds, and money markets.” On the other hand, Axel Lomholt, head of product development for iShares Europe, explains that their recent biggest initiative, has been the development of ETFs on the Barclays aggregate index family, previously Lehman Brothers’ aggregate index before Barclays bank bought Lehman’s US business. This index family covers many different asset classes in fixed income. Time with traders A key driver to the recent growth of assets in fixed income ETFs – in which iShares has €14bn and 63 per cent of fixed income market share globally – has been the time spent with the traders, to help them understand how they can trade them. “An equity trader who has only been trading equities, suddenly has a fixed income instrument, even though he probably never traded a bond, so it was something we need to work on,” says Mr Lomholt. He explains when he was a fund manager at HSBC he would have loved to use a fixed income ETF, to be able to trade one single security, rather than all the individual fixed income instruments separately. The ETFs that replicate Barclays Capital Aggregate index falls within the first of the three buckets of funds in which iShares diversifies its products set. These are the bread and butter, or traditional ETF core indices, explains Mr Lomholt. “Over the past 18 months we have seen across the industry an increased interest into the more core ETFs, and less interest in niche or exotic ETFs, which were very popular two years ago. This has been reflected in our product development process,” he says. “This is simply because more people are allocating the core part of their portfolio into ETFs. “The second bucket we focus on is giving investors’ broader and deeper coverage within an existing asset class, such as emerging markets, while the third bucket is geographical expansion and pure innovation.”