Emma Dunkley speaks to Lothian Pension Fund portfolio manager Bruce Miller and West Midlands Pension Fund chief investment officer Judy Saunders about their approach to ETFs
Lothian Pension Fund portfolio manager Bruce Miller
How do you use ETFs in your portfolio and why have you opted to use them?
Lothian Pension Fund currently invests in one ETF to track the performance of the FTSE 250 index in the UK. The investment was made to simplify the management of the portfolio, both from an internal fund management point of view and from an administrative point of view.
What is the ETF and what does it track?
We use the iShares FTSE 250, which is designed to track the performance of the FTSE 250 index.
Why do you think ETFs are useful?
They provide access to a particular asset’s beta. The cost of access varies quite a bit, but in general, they are quite transparent. Because they are tradable like shares, adjusting position size is straightforward.
Do you think ETFs are a good alternative to direct market access or using actively managed funds, for example? Or do they complement other vehicles?
ETFs can be a good alternative to direct market access in certain circumstances. The performance of the ETF should capture most of the return of the underlying asset, but it may underperform slightly.
The annualised total return for the iShares FTSE 250 since inception to 12 January 2010 is +11.00% compared with +11.55% for the index, so there is some leakage over the long term. In our experience, stock lending income has closed that gap to provide a similar return to the index, although that is not a risk free proposition.
We have used the ETF to complement our in-house active fund management function to allow more resources to be focused on stock selection in a narrower range of stocks. It has the added benefit of simplifying administration.
Do you think ETFs are an important tool that should be adopted by pension funds? For the long term?
We continue to look at ETFs as a possible tool to help us achieve the objectives of the fund. We do not expect to have a major part of our fund invested in ETFs although we can see how they would be useful for tactical asset allocation. The extent to which pension funds adopt ETFs will be determined by the ability/willingness of the providers to reduce expense ratios and by the extent to which pension funds participate in tactical asset allocation.
Bruce is a portfolio manager at Lothian pension fund, where he runs the internal UK equity portfolio and is involved in many other aspects of the fund. Bruce previously spent 15 years as an analyst/portfolio manager on the North American equity desk at Scottish Widows.
West Midlands Pension Fund chief investment officer Judy Saunders
Does the West Midlands Pension Fund use ETFs and if so, which ones?
We have used a range of ETF providers to gain access to the FTSE 100 and FTSE 250, the S&P/TSE 60 index (Canada), the S&P 500 plus the MSCI Europe.
How much have you allocated to these ETFs?
At the moment we have £50m in total invested in Canada.
Why do you use ETFs to provide this exposure?
ETFs provide the fund with an effective way of achieving immediate exposure to the equity markets either for tactical asset allocation purposes or to maintain its strategic benchmark if there are significant market movements in either direction.
What do you believe are the benefits and downfalls of using ETFs? How do they compare with index funds?
We actually manage £2.5bn of index funds in-house so we very much believe in the concept behind passive management. ETFs are used as a tool merely to support our in-house portfolios. One of their disadvantages is that it is not always possible to find an ETF to exactly match the underlying index which can lead to tracking errors and there are obviously costs associated with dealing in them.
Would you consider increasing your use of ETFs going forward?
We are unlikely to greatly change the fund’s use of ETFs going forward other than to use them on a short term basis as and when required.
Judy was appointed as the West Midlands Pension Fund’s chief investment officer in March 2005, having occupied a number of management roles within the fund, where she has overall responsibility for the investment strategy.
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