Thomas Becket of PSigma Investment Management talks to Joanne Young about using ETFs for everything from seizing the moment in equities to playing it safe with gold
How do you use ETFs in your portfolios?
The way we run money has completely changed since I started at PSigma seven years ago. As well as having between eight and 16 asset classes in our portfolios, we provide different ways for our clients to get that exposure.
There is still the more old fashioned approach of picking individual stocks, but we also manage client portfolios on a fund of funds basis – and that would include both ETFs and active funds. We may opt for an even greater reliance on ETFs, where all of a client’s developed world equity money is invested through ETFs.
The way we use these funds in portfolios is quite varied. For our average, balanced client we use ETFs for specific investments such as gold, or to pick up exposure to a particular index. Perhaps the typical way we use them is for market timing. If in the short term we take a positive view on an equity market and want to get market exposure, we have found ETFs to be the most efficient and cost-effective way of getting that. We manage about £1.3bn in assets, so it is pretty difficult to put £30-40m into an active manager’s fund and then just take it out once we have the return we want, whereas ETFs are useful for doing that.
How do you choose an ETF?
The key point to take away is that we put as much effort into due diligence for passive funds as we do for active funds. We carry out thorough analysis on structure, pricing, liquidity, how the product actually works and the stability of the company backing the ETF. The key factors for us would be liquidity and cost. Those two really form the crux.
Is there a provider you particularly favour?
All of our clients have exposure to gold through the SPDR Gold Trust. We are increasingly using ETF Securities – we think they are very good on the commodities side. We have used them in the past for an agriculture ETF and also for an oil ETF. We try to avoid investing too much with any one provider so we also have exposure to Vanguard and we have used a db x-trackers fund in the past.
What structures do you prefer?
We like to keep things as simple as possible, which means that for us the best way is using physical replication. Clients tend to understand that. Certainly with something like gold, which we bought as a safety insurance policy back in 2006 and 2007, it would have been pretty stupid to use an ETF that was not physically backed.
With regards to inverse products something to bear in mind is that a lot of people who invest retail money do not actually understand what they are going to get. The inverse ETFs are certainly something we have looked at, but I just do not think they are suitable for private clients. Investors are entering into an arrangement where they might expect to receive twice the returns of the market and then they do not get it.
What are the benefits of using ETFs?
Obviously there is the cost. Pricing is something we definitely consider when managing private client portfolios. ETFs also give you the ability to time markets better. When we first set up our retail fund of funds business, a week after Lehman Brothers collapsed, ETFs allowed us to express our asset allocation decisions more efficiently – and that is particularly important when the markets are volatile. I think market timing is a critical advantage that passive funds have over active funds.
The other aspect of ETFs is that you always know what you are going to get, as long as you pick the right product. People try to put too much science behind fund management; what they fail to understand is that when it comes to an active fund you are choosing a manager that you trust to look after your client’s money. That manager can do whatever they want with that money. It would be galling to call the market right, buy an active fund, and then fail to get the participation you might expect. ETFs have really opened up an opportunity for fund managers to be able to express the market more efficiently and know what they are going to get.
What is missing from the existing product range and what would you like to see?
I would like to see more diversified emerging market ETFs. A lot of the indices there are still stacked heavily in favour of the biggest components.
We had an experience in 2009 when we bought the oil price at $35 a barrel and ended up not making money for our clients because of the contango on the oil futures curve. That was something clients did not necessarily understand; they thought they were buying the oil price, and it took a process of education to explain that you are actually buying an index. So I think more efficient ways of playing commodities would be the way forward.
Having said that, I think the development of ETFs over the last eight years has been very good and there is a lot more scope for fund managers to be able to replicate their asset allocation decisions and investment calls more efficiently. I think if the ETF market continues to mature in the way it has done over the last few years, it will be of huge benefit to our industry.
How large a portion of investments do you think ETFs could make up?
The type of client who has opted for us to use passive vehicles for all their equity exposure will have as much as 40% of their portfolios invested in ETFs, but those clients are a much smaller part of our business. Our traditional clients have anywhere between 5-10% in ETFs, and that is up from nothing five years ago. There has been a change – it is still a nascent change at the moment, but I expect it to continue to develop as the industry does so itself.
Thomas Becket is chief investment officer at PSigma Investment Management, where he has worked for seven years. He heads up PSigma’s investment process and asset allocation decisions and pioneered the firm’s Wealth Management Solutions strategies.
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From 6 April 2019