Investors should avoid looking exclusively at fund fees when selecting exchange-traded funds, according to a panel of industry experts who addressed an event held by HSBC Global Asset Management last week.
Investors who focus exclusively on fees when choosing an ETF potentially run the risk of picking a fund that significantly deviates from its underlying index over time.
The speakers explained that while choosing an ETF with a competitive fee structure is undoubtedly important, investors should not discount the tracking precision of the fund as ETFs which do not perform well by this second metric potentially run the risk of consistently lagging their underlying indices by a notable degree.
Hortense Bioy, director of passive fund research in Europe at Morningstar, commented: “When comparing ETFs, the cheapest funds are not necessarily the best. Looking at the biggest equity ETFs in Europe tracking plain-vanilla indices, the differences in price are not as significant as the deviations in tracking differences.
“This is due to many factors, including funds’ domicile and the type of replication employed. There is a lot of information available about ETFs, their processes and performance… However, most investors tend to look only at headline costs when comparing funds used to access a particular market.”
Patricia Keogh, ETF portfolio manager at HSBC GAM, explained that in a crowded market where ETF prices have been driven down, HSBC believes it is ever more important to focus on perfecting the basics and returning to the client the performance they expect.
She said: “In our approach to ETF management, we believe three aspects are particularly important. First, advanced technology helps maintain a strict investment discipline supported by a robust risk control. Second, having an effective relationship with an administrator helps ensure the precision of valuation. Third, a centralised global dealing desk ensures that the client is getting the best execution around the clock managed by experienced traders.”
The speakers highlighted that different ETF providers may apply a variety of approaches to managing index-tracking vehicles, and investors’ decision-making process is significantly determined by the research resources they can access. In particular, retail investors may not be as discriminating as some of the institutional-type clients.
Ben Seager-Scott, chief investment strategist, Tilney, explained: “Clients with an institutional set up can usually do a good job on fund due diligence. Backed by good analysts and an execution team, you can get a lot of information and do more detailed analysis. But if a client comes to an execution-only platform, then they don’t look at funds in as much detail. So there is a big gap in the quality of fund selection between the retail market and the higher end wholesale clients.”
The European ETF universe now exceeds $600 billion and investors have a multitude of providers to choose from. While the significant growth has led to more efficiency in the industry, the speakers noted potential pitfalls still remain which may not be uncovered through an analysis of fund fees alone.
Tom Caddick, global head of multi asset, Santander Asset Management, said: “The saturation in the market has been a positive factor which is bringing fees down and squeezing weaker providers out. However, there are a few big market players who swallowed most of the capacity and there are some marginal providers. We have seen some esoteric launches from marginal providers which will probably never get significant scale which is required for many asset allocators in order to invest. They need to know that they can put in a large amount of money into a fund without becoming a dominant player in that vehicle. Currently the market has breadth but not scale but that will continue to evolve.”