by Dewi John.
On April 19, the Investment Association opened its doors to ETFs. Some 531 ETFs have been added to IA sectors, with assets totalling £383.2bn. The biggest sector gainers, in terms of number of share classes, are Specialist (80), Global (69), and North America (58). Most of these funds are passive, but there are 59 smart beta vehicles, which add £1.67bn, predominantly in the Global and North America sectors.
The largest promoter by far is BlackRock, which, weighing in at £288.1bn, takes most assets (table 1).
Table 1: IA-Listed ETF Promoters (£bn)
That brings the total AUM of all funds listed within the IA’s sectors to £1.198trn—an increase of 47%. This figure needs to be qualified, as these assets will not be specific to the UK. Going to the other extreme, if we only include those share classes that have their currency of record as sterling, IA-listed ETFs make up £25.3bn of £803.3bn, representing a more modest increase of 3.3%.
The latter conservative calculation assumes that UK investors are only represented by those share classes whose currency of record is sterling. Erring on the side of caution often has its advantages, but in this analysis we’re taking the broader number, as it captures all ETF assets that fall within the IA sectors. What’s more, one can be too cautious—while a decent rule of thumb is to look at domicile when analysing domestic fund markets, there are no ETFs domiciled in the UK, and clearly UK investors do use ETFs.
The effects of this change are, of course, more than on asset volumes. As an indication of the effect on performance, price, and effective index tracking, we will take a look at the UK All Companies sector. Some £14.2bn of ETF assets have been added here, with 15 fund share classes (this is the same figure for both the broad and narrow measure).
In performance terms, mutual funds are ahead, delivering 30.4% and 12.5% over one and three years, respectively, compared to 28.7% and 8.7% for ETFs. That, by and large, just shows active management has added value, particularly over three years. Average charges, in the form of Total Expense Ratio (TER), for the sector are 0.192% for ETFs and 1.268% for mutual funds. But so what? You pay more for active management, and that’s been a good overall bet over the two time periods.
So let’s drill down another level to compare passive mutual funds to ETFs within UK All Companies.
The TER for index-tracking mutual funds is 0.422%, and one- and three-year performance is 22.3% and 4.7%, respectively. Now, the difference in performance can be down to a different mix of indices between the ETFs and passive mutual funds, of which there are 237 at the share-class level. For example, the iShares Core FTSE 100 UCITS ETF GBP Dist returned 22% and 4.2% over one and three years, while its FTSE 250 sibling returned 43.9% and 22.3%.
Lastly, therefore, we look at those funds within UK All Companies that are benchmarked to the FTSE 100 Total Return, taking the Lipper primary share class only. There are four ETFs and 15 passive mutual funds that fit the bill, so the sample size is not massive. Nevertheless, the TERs for FTSE 100 ETFs are about 10% of that for their mutual fund equivalents (excluding dealing charges, which we’ll address below). On average, the returns of the four ETFs both exceed their mutual equivalents, and better match the index performance. That’s supported by the fact that the average tracking error for the FTSE 100 ETFs is 0.01, and for the mutual funds 1.08 (see table 2). All ETFs are fully invested in the FTSE 100, while only one mutual fund tracker makes use of synthetic replication.
Turning to those funds tracking the FTSE 250 TR, the sample size is much smaller—three ETFs and one mutual fund—so the results need to be taken with a pinch of salt. The latter is slightly cheaper, but the ETF returns are higher, and closer to the return of the benchmark, and with a lower tracking error (average 0.35 versus 0.95).
Table 2: FTSE100 and FTSE250 ETFs v Passive Mutual Funds—Cost, Performance and Tracking Error
However, that’s not the end of it, as unlike mutual funds, trading fees are not incorporated into the cost of an ETF and so will eat into the performance in a way not accounted for by metrics such as TER. The more an investor trades, the more those fees will stack up.
What’s more, unlike the existing incumbents, ETFs are (by definition) priced and traded continuously on exchanges, rather than priced daily. That can be an obstacle for many portfolios being run off platforms that don’t support exchange-traded products, whether individual equities, investment trusts, or ETFs. But many investors can make use of them, and no doubt will.
ETFs, no more than any other collective investment, are no silver bullet. But they are a useful addition to the investor’s toolbox.
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