Secrets Your Bank May Like to Keep

21 July 2017  |  Simon Miller
 Secrets Your Bank May Like to Keep
Expensive and disappointing aren’t a salesman’s most frequently used words.
Yet those words summarise a product that thousands of savers across the world continue to invest in. We want to encourage investors to shop around for a cost-efficient and effective alternative. ETFs are the investment tool of the future.

Expensive and disappointing. Not two words that buyers knowingly leap towards when considering a purchase; yet that is the reality of shopping for actively managed funds.

Time-poor private investors can’t dedicate hours to fund research, so often turn to investment professionals for help. These professionals will typically have a broad range of recommendations, but those recommendations may not always be entirely independent. We don’t think that this is the best solution for investors, but years of low interest rates have been tough on savers. Bonds and fixed-term deposits have not brought much joy, so what else is out there? We encourage investors to shop around and look for effective, low-cost alternatives; they really do exist. Exchange-traded funds, or ETFs, enable investors to globally diversify their capital; buying just one fund can offer an investor exposure to thousands of individual assets.

Seek out Those Hidden Costs

When it comes to actively managed funds, the term ‘costs’ encompasses a broad range of components. Exit fees, management fees, trading and custody costs all fall under the term ‘costs’, and the list doesn’t stop there. Investors should carefully scrutinise the total estimated fees before committing to the fund but that may be easier said than done. When it comes to investing, the word ‘opaque’ often precedes the word ‘costs’.

We were pleased to see that the FCA recognised this in their recent Asset Management Market Study. The asset management industry is working towards the establishment of a single ‘all-in fee’ and a standardised fee template, but investors should be wary of overpaying in the meantime; investor returns are significantly reduced by costs. You can read more about the impact of fees in our blog post, The Labyrinth of Fees.

74% of Active Funds Underperform Their Benchmark

Disappointing: the other drawback of active funds. When it comes to selling their fund, managers can promise the world. Somehow, they can see opportunities no one else can, and they are sure that next year will bring all of their ideas to fruition. These managers may have great faith in their ability to return stunning outperformance, but as we all well know, predicting future price movements is impossible. These managers cannot guarantee anything, so it comes as no surprise that actual performance can vary considerably when compared with desired performance.

According to research published annually by SPIVA, as at the end of last year, 74 percent of active funds across the world underperformed their benchmark over five years. 88 percent of large-cap US funds underperformed the S&P 500 over five years and 74 percent of European equity funds underperformed the S&P Europe 350 over five years.

The Vast Majority of Active Funds Underperform Their Benchmark

Percentage of European equity funds that underperformed their benchmarks, as at 31st Dec 2016

Percentage of European equity funds that underperformed their benchmarks, as at 31st Dec 2016

Past performance or future projections are not indicative of future performance.
Source: Spiva Statistics and Reports

The SPIVA research returns fairly similar results every year; the vast majority of active funds underperform their benchmark over both the short term (one year) and the longer term (five years). The high fees charged by these managers is one of the biggest causes of underperformance. Some managers may perform in line with their benchmark, but by the time the investor has paid all of the ‘costs’, returns aren’t looking quite so positive. Based on these statistics, we believe there is rarely any benefit to investing in an actively managed fund.

The Better Alternative

Expensive and disappointing. No wonder alternatives have taken the market by storm over the past few years. More and more assets are flowing into passive funds and, according to MorningStar, 2016 marked the first year that flows into European passive funds (£67bn) overtook flows into European active funds (£39bn).

It’s clear that passive investing is on the rise, partly facilitated by the rise of ETFs. These exchange-traded funds tend to follow a benchmark so most are considered to be passive instruments and therefore do not incur the same sky-high active management fees. As they follow the benchmark, they don’t struggle with the same underperformance issues that actively managed funds do. They also offer the same broad diversity offered by actively managed funds, some ETFs offer exposure to an entire region or asset class in just one transaction. They are also highly liquid and highly transparent, due to being traded on exchange. These factors certainly make a strong case for ETFs.

Our Investment Universe

At Scalable Capital, ETFs are most certainly our preferred investment tool. The new wave of digital wealth managers seems to agree with us and you’ll find that most invest using ETFs.

Opening a portfolio with us is simple. You will need to answer a questionnaire for us to be able to gauge your tolerance to risk, your time horizon and investment objectives as well as your investing experience. On the basis of that information, we will construct a portfolio of ETFs that is suitable for you.

We regularly adjust your portfolio according to changes in the market and shift asset allocation if we think that the risk in your portfolio will breach your chosen risk category in the long term, either positively or negatively. When we anticipate sustained periods of higher market volatility, we will reduce the weighting of higher-risk assets in your portfolio. When we foresee market volatility falling, we will decrease the amount of lower-risk assets in your portfolio. This means that risk in your portfolio remains the same long term in all market conditions; you never take more or less risk than you want. We are able to manage client portfolios in this way as our sophisticated algorithms analyse the historical behaviour of all the asset classes you’re invested in and use this data to reliably forecast the risk in your portfolio over the course of the next year.

The most important message for our clients to understand is that the risk that they initially select for their portfolio will not change throughout their time as our client (unless desired). This is not something an actively managed fund can deliver, and private investors who select ETFs or other funds themselves will typically also lack the data and tools to keep risk under control in a similar fashion. We believe that this type of risk control provides investors with a much less stressful investing experience and helps them to stay invested for the long run; one of the key success factors for investing. Our fees won’t damage your returns either; the annual fee is just 0.75 percent plus 0.25 percent for the ETFs. That’s it, no other long list of hidden charges anywhere. Quite the opposite to expensive and disappointing.

Note: We re-calculate our average ETF fees on a regular basis to make sure they reflect current portfolio averages. The fees mentioned in this article were accurate at the publication date. To view our current fee structure please visit our fees page.

Source: http://us.spindices.com/SPIVA/#/reports
https://www.ftadviser.com/investments/2017/01/24/passive-fund-flows-outpace-active-for-first-time-since-2011/

Risk Warning – With investment comes risk. The value of your investment can go down as well as up and you may get back less than you invest. Past performance or future projections are not indicative of future performance. We do not provide any investment, legal and/or tax advice. If this website contains information regarding capital markets, financial instruments and/or other topics relevant for investments of assets, the exclusive purpose of this information is to give general guidance on investment management services provided by members of our group. Please note our Risk Warning and the Website Terms.

 

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Simon Miller
UK CEO & UK CO-FOUNDER
Formerly a derivatives trader at Barclays Capital, Simon merges capital markets knowledge and business development skills with an academic background in Economics, Business and Mathematics.