However, a search through the portfolio holdings reveals a list of well-known brands such as iShares, Vanguard, UBS and Powershares and established index providers, such as MSCI, FTSE and Nasdaq.
Regardless, McManus noted even big index providers can make a mistake with rebalancing activity. In February, UK Dividend Aristocrats ETF investors lost money when S&P Dow Jones failed to remove Carillion from the index in its December rebalancing.
Nutmeg prefers physically-backed ETFs.
Fund house consistency
When it comes to due diligence on the fund house, Nutmeg looks for consistency of performance, performance of the manager and the other portfolios they manage, McManus said.
“If it’s a Japanese equity strategy, are there other Japanese equity strategies that the manager runs? Mandates, index funds, mutual funds, what can we look at to ascertain their consistency over time?”
He added: “We want to know the portfolio managers: where they’re sat, what systems they use, the risks and controls they have, what portfolio management tools they have available, the resources they have available.”
Tracking error is “clearly” an important consideration and when the fund is underperforming its fee level the team tries to understand why, he said.
“Is there something structural there?” A high bid-ask spread on underlying securities could make perfect tracking of an index “impossible”, he said as an example.
Scrutinising the T&Cs
Legal details, fund domicile, tax advantages, fund pricing and NAV calculations are the “minutiae” Nutmeg assesses in the final steps, McManus said.
When it comes to securities lending, Nutmeg’s investment managers want to ensure how risks are managed and whether they are being paid for those risks, he said.
The more investors in an ETF the better, said McManus, but he added liquidity is not just defined by the number of other investors in the product and there is no “arbitrary” level of AUM an ETF must hold in order for Nutmeg to invest.
The robo adviser’s investment team works with market makers to understand liquidity dynamics from the trading side, finding out the costs to the market maker of buying the underlying securities and packaging them.
“It is different market to market. If you look at some of the bond ETFs where they’re priced at bid rather than mid that’s a critical dynamic to understand,” he said.
