PART 1
The Panel:
Deborah Fuhr (DF), managing director of investment strategies at Morgan Stanley
Eleanor Hope-Bell (EHB), head of wealth management sales at BGI iShares
Socheat Chhay (SC), a director at ETF Securities
Charles Mackinnon (CM) Chief Investment Officer at Thurleigh Investment Managers
Patrick Murphy (PM), director of wealth management at Thinc
I am Rob Mackinlay (RM), a Financial Express reporter writing for Investegate.co.uk and Trustnet.com
Question: According to Wikipedia: "More than half of ETFs in the US are held by retail investors. One third of European ETFs stock is in retail investors hands. There is every indication that the markets are heading the US way." Do you agree?
EH-B: The research we’ve done at iShares certainly indicates that is about right so in the US at the moment we estimate that about 55 per cent of total ETF holders are retail and 45 per cent institutional. What we are seeing in Europe is the same kind of pattern in that the early adopters are institutional investors and we project that the same kind of shift will happen in the next 3-5 years.
We can have this debate about whether US investors are financially more educated but the role of an intermediary is the same in the US as it is in Europe. Traditional credit banking is far more advanced in Europe than it is in the US.
But if you think about classic retail investing in the states its probably more along the lines of retail investing in the UK.
What we’re seeing in terms of a migration from commission-based to fee-based is what we saw in the United States. We think retail investors will become greater adoptors of ETFs part of this is greater education and awareness, part of it is RDR and MiFI which will allow investors to compare products across the board and greater competition across the industry.
Left: Rob Mackinlay Right: Eleanor Hope-Bell
Left: Charles Mackinnon Centre: Patrick Murphy Right: Deborah Fuhr
SC: I would confirm the iShares point of view. In the US the retail holders seem to be at about 50 per cent. A few years ago in Europe about 85-90 per cent of ETF holders were institutional and it went down to around about two thirds and we presently have around the one third retail, to two thirds institutional ratio. We do believe also that there is going to be a major shift toward retail. we can already see it through the smaller volume deals that are being traded on exchange so we definitely see this shift to more retail already happening.
Socheat Chhay
EH-B: But let's be clear here though. In terms of identifying a retail holder it is very hard to do. Its just operationally and technically difficult to ascertain.
CM: In truth I think that the ratio here will probably stay more stable. I think that the over all take up of ETFs will continue to grow very dramatically but I’m not sure there will be a shift in the balance between retail and institutional. I think that small institutions, of which there are many, will increasingly adopt what I think iShares calls a hub and spoke approach.
They will choose the FTSE 100 or the S&P 500 and will say: "We know we’re going to have 50 per cent in this and that iShares will do that for us for 40 basis points as opposed to trying to generate alpha by giving it to another manager."
Charles Mackinnon
CM: And so I think the instititutional growth will continue. On the individual side I think there are two groups. The self-directed group that Eleanor mentioned, where they will see that, if you want to own the FTSE or you want to own the oil producers, this is a cheaper better way of doing it. And so that will probably increase the number of holders. But in terms of volume I don’t know. The big thing in the UK market is that it is driven by IFAs and of course IFAs don’t make any money out of buying iShares where as they might from an unspecified UK income fund. From a fund they are going to get 25bps a year. I’m sure they’re doing a perfectly adequate job but they are going to get paid to buy that income fund. If they put money in iShares, which has at least as good a chance - in fact statistically has a 75% chance of doing better than any manager they choose - but the person making the choice will receive no money. So, unless there is a functional change in the habits of the brits - in terms of how they acquire investment products - I don’t see that shift from instititutional to retail ownership.
EH-B: You don’t think that legislation is going to try and drive that through and put fiduciary responsibility onto the IFA?
CM: I think IFAs are probably mostly good people and lets be very clear, most of those people have done a very good job for most of their clients and they need to be paid, most clients accept that. So if they have a choice between two assets, they can present that to the client, and the client generally says I’m happy for such and such income fund to pay you for your time, as opposed to me. So i don’t see legislation doing much. Its like the difference between Easyjet and British Airways. Lots of people choose to fly Easyjet and not get the free lunch, which they were paying for anyway at British Airways.
PM: First of all I think the difference between US and UK is very much as has been said. I was in Chicago in December talking to a couple of firms of broker dealers over there and it taught me a lot about the origins of the broker dealer networks there. In simple terms, UK IFAs come from a life assurance company background, with product, insurance company product commission-based sales culture where as in the US there is a very clear division. You sell life products and protection and you are a broker dealer with origins from the stock broking investment world. And I think the consumer is much more savvy. You go into a newsagents in the US and there are magazines about investment. Here it is about property. So I think the US investor is much more aware of costs and, in fact, total expense ratios in states are much more easily understood. So the direct purchaser is a lot more savvy and there aren’t that many of these in the UK. I think Charles is right, the UK IFA traditionally will only sell products that generate commission. Although I think RDR is trying to change that. Just as an example, the part of the business that I work for, Thinc Wealth Management, we are a completely fee-based business. Although we don’t use ETFs we use institutional passive funds with 25-50 basis point costs from Dimensional Fund advisors and so we very much believe that it is possible, by charging fees and using low-cost passively managed rather than actively managed, we can deliever a much better propostion to the client. And we are in an incredible minority. But it works. It is very profitable, we charge the client 1% a year, the wrap platform charge for a £250,000 + portfolio is 38 basis points and we’re buying funds at 25 to 50bps so total cost is about 2% a year. For that the client gets a very comprehensive service. It is possible to change the model but its going to take a long long time.
Patrick Murphy
PM: And, in fact, within IFA world the problem isn’t whether or not they should be recommending ETFs, the problem at the moment is one step away from that. We’re still having a debate about why investors should not be sold insurance bond products as opposed to a retail OEICs or unit trusts. The reason is very often that the bond product carries a much higher commission. I think the pre-budget report may change some of that, but I think there’s a huge lack of education in IFA world about the whole principle around investment philosophy. There are still a lot of IFAs who think the value they add to a client is in selecting fund managers and selecting styles.
DF: I would say that Europe is probably lower than the figures you’ve got there. And especially the UK is smaller in terms of the use by retail. But then I guess its a question of whether you are drawing private banks and high net worths into that pool - it depends on what the break-off of point is. But we’ve done a survey going back looking at data from mutual fund holdings. We looked at how many institutions had used ETFs listed anywhere in the world.
To give you rates of change, if you looked at 1997 which is when I started covering ETFs, we had 21 ETFs and $8bn globally and we saw there were 165 institutions around the world using ETFs. Last year there were 2214 institutions using ETFs so it really has expanded. I think I can draw some analogies to what we saw changing over time if we look at private banks as an example.
When I started talking to private banks in Switzerland and in Europe you would hear them saying “I’m an active manager I have no interest in these kinds of products” or “are you going to pay me a rebate” and the answer on the rebate was no. But what you have found over the years is that they have embraced using ETFs as a tool box of types of exposure and the types exposure you can use them for has grown.
Often they can’t find other funds that will pay them the rebate or the other funds aren’t beating the benchmark so you pay a lot of money for an active emerging market product that significantly underperforms. The other appeal that they found over the years is the fact that you have daily liquidity in very small sizes - 200 euros, get in, get out - has made them a useful tool for both retail and high net worth private banking. So I think there has been a real shift as the idea has grown that ETFs are a tool that you might find useful for certain things.
Deborah FuhrDF: To the last speaker I would say that as people move more to wrap accounts – and there are others like Seven Investment who also have wrap accounts - where they will embrace using ETFs, where they’re not getting paid based on commission. So I think the model is changing, with Mifid and other things requiring the disclosure of rebates as well as investors becoming aware of how people are getting paid. Yes, if they’re providing a service, I take the point that it’s not a problem.
If the customer is happy with the service then that’s fine, but if you find that you’re paying a lot of money and getting lower returns than you might have gotten by just finding something yourself, then you might want to look elsewhere. So I think, as people become aware of alternatives and the costs and the different types of costs, I think that ETFs do become an appealing product to be used.
RM: Should education about ETFs for retail and institutional investors come from providers?
EH-B: I would say the need for education exists in retail and institutional and I would say, unfortunately, this has fallen to the ETF provider. Is it right or wrong? It’s a good question. But I think the education from the provider’s point of view is actually to the intermediary, we’re not B to C, so we’re not talking or selling directly to an individual. That’s the wealth manager’s or private bank’s job. We will never know the profile or circumstances of the client so the provider’s job is to educate the intermediaries whether its an insurance company, private bank etc. Certainly at iShares we take education as one of our dominant processes. We spend a lot of time on creating educational collateral to help facilitate that education process because the reality is that, until that intermediary market is educated, its very hard for the end consumer to feel like they’re educated.
SC: We believe that education is one part of the whole process, from construction through to the listing. I personally spend my time travelling across Europe to educate through conferences and through head to head meetings with private bankers and also a lot of asset managers on how to use ETFs within their portfolio, how they operate, how much they cost. So we really do believe that education is part of the issuing process.
RM: ETF Securities seem to combine this with an argument for investors to put commodities in their portfolios, so its as if you are telling people they should put commodities in their portfolios when they might not have thought of it before.
SC: Well it depends on the people we meet. The private bankers and asset managers, if fully depends on their knowledge. Some of the people I meet don’t even know what an ETF is so I have to start from scratch and explain what are ETFs and within that I will mention the players around and all the asset classes you can play and within that, we are commodities.
DF: But can I just point something out? Your products aren’t actually ETFs and that’s part of the issue that your firm often creates confusion by not being as clear as you could be because they are notes. So for many investors the regulatory implications of using ETCs which are notes, as opposed to ETFs under the UCITS guidelines is very different. And I think that is an example of how it is very important that you are clear. And your name is confusing and the product names are confusing for many people.
CM: But I think that’s a question for the intermediary.
DF: No but they’re not clear in their presentation which I’ve often heard and seen, I think that can be a real issue for people being able to use the products because if you sit there and say these are ETFs and we are ETF Securities, people assume these are exchange traded funds.
SC: I would say that we always saying that we are exchange traded commodities and we use the term exchange traded commodities, we never say funds. We might actually say why we are not funds. In Europe we do say trackers and we do track an index or an underlying which could be a commodity. Although we don’t have the ETF structure we do replicate and track the underlying.
EH-B: I think that is a good point though. It is no longer just ETFs. The whole category is continually evolving and innovating which is not a bad thing. But what is bad, though, is the confusion in the market. The lack, which is Debbie’s point, the lack of transparency. So ETFs by nature should be transparent and this should include the structures and characteristics around these various instruments which are now on the market. And I think its really important for the investor, lets be clear I think its up to the ETF provider or the ETF category provider.
DF: ETF product. Eleanor: Yes, ETF product provider, it is up to us to make the intermediary absolutely clear on what the characteristics are of the structures. RM: Are you, for example talking about using instruments like swaps to remove tracking error - as Lyxor does?
EH-B: Oh, sorry I’m thinking in terms of education. So the provider is absolutely 100% transparent in terms of what the structure is, what the considerations or characteristics of the vehicle that your buying. BGI iShares also have swap-based products in our German fund range so the point is we have to be crystal clear to our clients what it is that they’re buying so if there is risk, clients are aware of what it is, how it is produced and what the implications are versus other structures like cash funds.
CM: For me, my business model is the same as Patrick's. We’re not an IFA but we’re fee-based. When we meet individual clients, very wealthy, very successful individuals, they have never seen or considered an ETF. They have been routinely and poorly sold active management and had very poor outcomes which is why they are changing their managers. And they don’t need an extensive period of education. You say at the moment you’ve got 40% of your assets and you’re in Glaxo, BP, Vodafone, and guess what, you look at the percentage of those stakes and you look at those relative to the FTSE and what you’re getting is an expensive and poor replication of an index. We can achieve the same level of risk at a lower level of cost, or we will at least know that your portfolio will more closely follow the FTSE because that’s what you want. And that, in some cases, is extraordinarily difficult for people who have spent their life time being sold individual equities. But then people become very enthusiastic. But again, following Debbie and Eleanor’s point, it is absolultely key that you know what you own. And that’s perhaps the harder part in that, in regard to ETF Securities, or other tracking assets, which are very valuable parts of the portfolio, but they are not an ETF, they are not an exchange traded fund. They are not a passive tracker of an investment I can buy and sell on the London Stock Exchange which is what my clients would see as an ETF. And again the Lyxor product is a different thing, not badly different, and for many clients they wouldn’t care, but it is subtley different and so that’s where the education of the underlying sales person or allocator, who makes the choice, is terribly important. Because in periods like now, with intense volatility at points since August last year, some of these - and I say this anxiously- securities, have moved differently than you would have expected, is the best way I can put it. Not to say they’ve done anything wrong, they may have done exactly what they were constructed to do, but we may not have appreciated that that is what they were going to do.
RM: Is that a reference to your holding of a dividend-weighted ETF?
CM: I used to own iUKD (tracking a dividend index) which is a Barclay’s iShares. I had not really paid attention to the fact that by virtue of owning this I was much longer financials, I just thought this was buying a dividend enhanced FTSE, very useful for a bunch of clients who wanted a high dividend flow. I hadn’t really thought it through that that meant I owned Norther Rock! We did dispose of this back in the summer when we started to notice it deviating the wrong way from the FTSE having done very very well. Then we started looking and we said, well look, its actually 18-20% financials (I can't remember the figures) as opposed to 12% in the FTSE. But we have all the facililties and it is what I am paid a fee for, but even with all this we nearly got trully, royally hosed - and we were not naive investors.
EH-B: But the transparency was there.
CM: Yes. The transparency was there, we could see right down to position level and we do go down to position level on all of our ETFs for all of our clients and all of our risk monitoring so we know exactly what we have in our portfolios.
EH-B: And there is the fact that when you wanted to get out you could get out to.
CM: Yes. But it’s not as easy as you might imagine. That may be a function of our size, but we’re not selling hundreds of shares, we’re selling millions. If we were doing 10s of millions you’d come and create for us or redeem for us, so that for the moment we’re sitting in a difficult space. We’re not big enough to create units and destroy them, but we’re too big for the routine retail flow.
EH-B: But I suppose that the more entrants to the market and the more buyers there are, the more that will be facilitated.
CM: But it’s astonishing how... I suppose you must have data on this, but we’re amazed at how thin liquidity is.
RM: Patrick, what’s you’re view on how Providers should educate IFAs and whether there’s anything to be learnt from Dimensional.
PM: Dimensional place a huge amount of emphasis on education. Firstly they will only deal with fee-based advisers, secondly they will only deal with you if you have been to their two day conference and understand efficient market theory and understand the whole logic behind the whole Dimensional story.
RM: So they are pretty exclusive.
PM: They are very exclusive and its very very unusual to find an investment house that comes at it from the acadmic approach as much as Dimensional do. The answer to your question though is that I’m always very sceptical about education from product providers because it tends not to be objective an academically based. It tends to end up with a solution that happens to be a product they sell. So I think education is essential.
There is a massive need for it in the financial advisory market, the average level of knowledge of an IFA on investment matters is extremely poor and a little knowledge is dangerous which is why, possibly, many of them use third party, fund of fund manager of mangers and abdicate responsibility. And I think it is possibly not just the product providers that should be educating. DF: Well, I guess everyone has to educate.
I spend a lot of my time educating. In the last 48 hours we’ve put out a piece on exposure to emerging markets, and later on tonight or tomorrow we’re putting out a piece on investing in commodities which of course is ETFs, ETCs and ETNs, a little bit of everything. So we talk about the differences in the products, help people understand what the products are, how they work, where the liquidity comes from.
And I guess I can relate to what was said about ETF Securities, if you’re only covering one asset class then they go hand in hand. When you’re covering multi-asset classes then the asset class follows on, depending on what the client wants. I think the exchanges also need to tell what are the requirements on the exchange because, for a long time, there was confusion about whether there was stamp tax to be paid on the London Stock Exchange.
I think understanding all the parties is important. The index providers have to help people with their indices. Now we have this whole debate about fundamental indicies versus market cap. If you listen to Rob Arnott,with the FTSE RAFI, one of the champions of these indices, he’ll say you get alpha if you use his index. Then you have Jeremy Siegle helping with WisdomTree who says, no, we were the first.
Then you have GWA saying it was first and its methodology is better. I think its everyone’s responsibility to educate people on their aspect of it. Its really a consortium because even brokers, who don’t usually work together, find that they do work together. And I think it is important which broker you deal with. So your point, (Charles) about having issues with liquidity, I end up doing a lot of educational meetings with private bank-type organisations and they’ll call me and say: I bought the such and such ETF, when are you going to get the trade done? And I’ll say did you speak to Jeff our trader?
And they’ll say, no we spoke to someone else. And so it’ll come down to, if you’re trading in millions, you need to trade with a broker who can do creation/redemption and if you go to someone who can’t, you’ll find that either they don’t get you done – which is probably better than getting you done - and offering you a higher and higher price. So I think that understanding the roles, the expertise of each player in the food chain, is very important.
You also have to decide whether a certificate is better than an ETF but it is also just understanding that you’ve made a choice. And may be an active fund might be better, if you look at Bill Miller in the US for 10 years beat the S&P… and then unfortunately he didn’t. But that’s the challenge. If you’re still finding people with alpha then go for it, but when it gets difficult, know that you have these tools that you can use. But make sure you understand them.
EH-B: So is what is needed an ETF 101? The problem is that because it is evolving so quickly, now you have active ETFs, inverse ETFs and fundamental indices, but the problem is, if you’re still at ground zero and trying to work out what an ETF is, you’re getting a PHD-level education from your provider and the media when, actually, you need to go back to square one, back to 101, and learn the basics. Part of the problem is that you have a lot of information thrown out very quickly.
RM: So does that mean a lot of people are already buying ETFs without really understanding them?
DF: One point I would add: quite often we say to people do you know what an ETF is? They’ll say no but then you mention a product like a spider (SPDR (Spider), which tracks the S&P 500 index) or the QQQQ (Nasdaq-tracking ETF) they’ll say yes, I know what they are. So, sometimes, its calling everything by initials and jargon can be confusing so people know it when they say they don’t. But I think the other point is that people will say they know ETFs but, until they are actually ready to invest, its one thing to say I know – It’s like when you buy a car, you know what a Lexus is but, if you’re going to buy one, what you want to know is very different from what you want to know if you just want to be able to point one out on the street. Unfortunately, even the US, where we’ve had ETFs since 93, you will find there’s still education that’s needed.
PM: Talking about it to the end user, one of the biggest challenges I have is to explain to clients why we have a strategy that isn’t constantly chopping and changing the funds and chasing performance and its no coincidence that the journalists and advertisers tend to be focussed on retail investment funds and flavours of the month and speculating versus investing. I think there’s a whole issue around public education about the difference between longterm investing and gambling.
The discussion has been divided into parts 1 & 2