John Fletcher, head of exchange-traded products at Charles Stanley, looks at how investors can differentiate between the growing number of ETFs
You could be forgiven for thinking that there are too many ETFs on the market at the moment that are all doing the same thing. I often hear from clients and brokers alike that the ETF space has become increasingly crowded. One of the single biggest obstacles to a private client investing their hard-earned cash into an ETF is the extensive, and thus sometimes confusing, array of choice open to them.
Let’s look at an example. Unless you have access to a Bloomberg terminal, it can be reasonably difficult to search for an ETF. A PDF copy of BlackRock’s Global Handbook would perhaps be the next best thing, but this is not easily available to most private investors. I am often asked to find an ETF that tracks a specific element, for example, an index, region, or sector, among other factors. If one were to search for a FTSE 100 tracker for example, a Bloomberg search throws up no less than 47 ETFs. Many will be cross-listings, or in different currencies, but essentially there are – at least in the eyes of someone new to this investment class – 47 ETFs doing pretty much the same thing.
Look at the options
How does the average investor then choose from this range? How does he start narrowing down his choice when he is unlikely to have access to a Bloomberg terminal?
When confronted with such choice, perhaps the investor would default to the market leaders, iShares, db x-trackers or Lyxor? However, even with these providers there is a hierarchy in relation to assets within the fund. I have filtered down the 47 ETFs first listed, to six using the criteria of whether they are traded on the London Stock Exchange (LSE), GBP trading currency, primary benchmark either being FTSE 100 index or FTSE 100 Total Return index, and then by assets.
The market leader by far is iShares with its FTSE 100 tracker, followed, not so closely, by db x-trackers and then Lyxor. However, Lyxor have an ETF that has attracted a relatively small amount of around £15m of funds. This to me could be a concern as historically smaller funds have been wound up if they are not deemed to be economically viable to run (which is not to say that this will happen with this particular ETF). You therefore potentially run into a vicious circle; namely, investors will continue to invest in the most popular funds at the expense of the less popular, and thus add to the risk of an eventual de-listing of the smaller fund.
De-listing is an ever-present risk from any ETF provider. This poses all sorts of problems for investors who have invested into the less popular funds, not least the inconvenience caused by extra trading costs from having to sell the fund about to be de-listed to buy into another. There is also the potential problem that one might not be informed that the ETF is being de-listed until after the event.
I believe that we have reached saturation point with the sheer number of products in the investment space which fundamentally do the same thing. I feel that unless the product offering is niche, along the lines of the excellent commodity exchange-traded products from ETF Securities (when they first arrived on the scene), a climate change ETF from Osmosis Capital, an active ETF from Marshall Wace or an intelligent index from PowerShares, or shows a much lower than average tracking error (another very important variable in the decision making process), then introducing a new fund doing something that is already covered seems to be a little wasteful.
Of course, a large number of similar ETFs do have the effect of reducing total expense ratios (TER) and while this is healthy competition, it can contribute to a confusing market place. As ever, it is important that prospective investors read the investment literature, including any key features documents, and if uncertain about any aspects of an investment product they should consider seeking advice from a suitably qualified professional.
The ETF market in Europe recently celebrated its 10th anniversary. Over this period the main ETF providers have gone to great expense to educate and inform possible investors and I am looking forward to the next 10 years and what may be around the corner with new and innovative products. I am just hoping that over this period a form of Darwinian natural selection might take place on some of the smaller funds on offer.
John Fletcher has worked at Charles Stanley for seven years, managing investments for a range of private clients and small institutions. He trades equities, derivatives, ETFs and ETCs based on his own technical analysis.
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