Are passives polarising the UK market

The latest IMA statistics indicate record inflows into passive funds as investors clearly signal their focus on cost and performance.

Are passives polarising the UK market

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Reflecting this trend, Vanguard announced on Thursday a price cut on over two dozen tracking funds. With fees on some of the funds now as low as 0.07 basis points, it is clear that the UK market is changing but how do investment experts see tracker funds evolving in the future?

UK market

Passives also saw a surge after the retail distribution review (RDR) was implemented. As a result of RDR, investors have far better access to passive products, which traditionally claimed a commission or rebate on platforms, which is now banned.

Historically the UK has had very mediocre active funds, according to Laith Khalaf, senior analyst, Hargreaves Lansdown.  

Often these funds were run on a core basis, did not take much risk compared to the benchmark, and were neither fully active nor fully passive. But as passive funds continue to lower their prices and investors become more switched on to what they are paying so, in creasingly they are demanding proper active management. As a result the market is gradually polarising into low cost passive funds on one hand, and active managers with a proven track record on the other.

The passives market is as diverse as its charging structure, with a huge variety of costs. But still most tracker funds cover known markets and are rooted with in equities as an asset class.

“A lot of passives cover core equities in the main markets, such as US, UK, Europe and Japan. These are standard fare. There are less passives in mixed assets and the bond market,” Khalaf said.

He points out the BlackRock offers the Corporate Bond Tracker Fund, an L&G the Gilt Tracker Fund, products offered by the two largest passive providers in the market.

Trackers versus ETFs

While they both belong in the passives family, tracker funds and ETFs have slightly different characteristics.

“Tracker funds are able to provide a more broad exposure, while ETFs allow the investor to drill further down. ETFs are a lot more granular,” according to Ben Thompson, a director overseeing Lyxor’s ETF business.

Identifying which passive product to choose can be tough due to the plethora of new products flooding the market, all offering the same exposure with an alternative method.

“Education is a huge part of the market growth. Investors need to check the relevant reading, and they need to look at the index to see what countries the product is focused on. There is a lot of power in selecting the individual countries and sectors,” Thompson said.

He also warned that the cheapest ETF may not be the best.

“The product might be cheap, but it may also track badly. The focus should be on efficiency, the total expense ratio is not the whole story.”

Investors need to get the asset allocation right, according to Nick Blake, head of retail for Europe at Vanguard.

The allocation is made worse by new products that enter the market.

“Smart beta products have risen in popularity. It sounds terrific – a product that is both smart and beta – but investors need to study the product and ask whether it is both smart and beta,” Blake said.

When buying a tracker fund or ETF, he cautions, investors need to look at the product from a three-pronged angle. Cost, performance and the trade efficiency are all factors that will contribute to investor profit.

Wealth manager perspective

Passives are a very cheap way into the stock and bond market, but investors need to be very mindful of how the index is built.

Some areas of the market are best not to get exposure to, for example emerging market tracker funds, according to Richard Philbin, CIO at Harwood Capital.

Other tracker funds, such as the S&P 500, are a better way of gaining exposure and certainly have a place in portfolios, he added.

He is certain that passives have an important role to play for advisers and wealth managers.

“From an advisor perspective, passives are gaining momentum and clients are demanding them. Passives will play a greater role from a cost perspective.”

Talking to advisers, he noted that 20-30% of advisor portfolios are in passives in order to be in control of costs and charges.

But, no two funds are the same and there is no exact same return so choosing the product is not an easy thing.

A definite trend in the future is towards income related strategies, according to Philbin.

“Investors are keen to use smart beta rather than only passives. These are market-cap driven, with exposure to the UK market.”

He added, “There is a programme for every investment out there, the products have all become quite specific.”

A feature on Smart Beta appears in the upcoming issue of Portfolio Adviser magazine.

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