Reid Steadman, the Hong Kong-based global head of exchange traded funds licensing at S&P, tells Hubbis how investors should view opportunities in this asset class within the context of their overall asset allocation.
Date: July 2011
Tags: ETFs, Asset allocation, Active management, Passive management, Indexes, Diversification
ETF providers cover a broad spectrum of underlyings. What will be the next stage of innovation?
We believe that ETF providers will begin to offer funds which offer greater access to international markets, particularly those outside the Asia Pacific region.
Currently, more than 90% of assets in ETFs in Asia Pacific are in products that provide exposure to the market in which the ETF is listed or a neighbouring market. S&P Indices, which calculates indices such as the S&P 500 (US) and the S&P/CNX Nifty (India), will work with partners to be at the forefront of this trend.
Is now a good time to invest in ETFs?
If you are interested in the markets at all, it is always a good time to consider transitioning your investments to ETFs. They offer many advantages that make them attractive investment tools.
First, they provide a high level of transparency because they typically track published indices. Secondly, they provide liquidity because investors can buy and sell out of positions throughout the trading day. And thirdly, they typically have lower annual management fees than other types of investment vehicles, including mutual funds.
These are benefits an investor can capitalise on, regardless of the direction the market is taking.
What types of investors are most suited for ETFs?
ETFs are popular with institutional and retail investors, and offer benefits for both groups.
ETFs have steadily gained acceptance as a multi-purpose tool in institutional portfolios. These investors are using ETFs for both strategic and tactical allocation purposes, as well as for various other reasons, such as looking for places to store cash while they search for companies in which to actively invest.
We have also seen ETF providers expand their product ranges in more specialised areas to cater to the growing number of retail investors using the product as a portfolio construction tool. Retail buyers like ETFs because of how easy it is to invest; they can simply buy into an ETF just as they would buy into a stock, by executing a trade on an exchange.
What should be the expected investment returns when buying ETFs?
Each investor needs to make their own judgment about the return potential for the ETF they hold. The first step in doing this is looking at the index that underlies the ETF; the index defines what asset class and what investment method is being used.
Once an investor knows this, they are equipped to seek out market information and professional advice on the asset class their ETF tracks.
How would S&P advise investors to include ETFs in their asset allocation process given today’s market environment?
One key to investing in any market – whether it is a bull or bear market – is to properly diversify across markets and asset classes.
Investors should consult with investment professionals to determine the right mix of equities, bonds, commodities and other securities that optimally position an investor for the best return at the lowest level of risk. They should then seek out the ETFs that can help execute this strategy.
What are the key differences between active and passive asset allocation?
In active asset allocation, an investor or fund manager is making judgments about which individual securities will outperform the broader market. In passive allocation, an investor is typically investing in the whole market, or a broad segment of a market, to diversify their holdings.
The biggest differences between these two strategies are in cost and performance. Hiring an active manager or executing an active strategy yourself can be expensive. You have to spend a lot of time analysing the vast universe of companies, or hire someone – who typically charges a lot – to do this for you. Even after all this analysis, many active managers have difficulty consistently beating the market. They might do so for one or two years, but it is rare that an active investor can outperform consistently.
With passive investing, an investor typically invests in a diversified basket of securities representing a market or a security, such as an ETF, representing this basket. This basket typically consists of the constituents of an index. The investor gets the return of the index, and because they don’t have to pay for the services of an expensive active manager, they can do this typically at a lower cost.
What underlyings should investors consider to maximise returns?
When allocating their money, investors should not just think about maximising returns on their own, but instead about maximising returns at the lowest level of risk possible.
A prudent investor who balances return and risk will typically diversify their holdings, and a great way to do this is through index-based ETFs.
An investor who is simply looking to maximise returns will sometimes find it best meets their objective to invest in one or two “hot” companies which they think are going to outperform the rest of the market. However, there are inherent risks in this approach.
If this highly-concentrated investment unexpectedly sours, an investor can lose most of their money. On the other hand, while an investor in an index fund or ETF can also experience downturns, typically they will not face the level of volatility associated with holding a small number of stocks.
