Wellian Weekly 08.03.2021

Why the future isn't ETFs

I am a big fan of Exchange Traded Funds. In my view they are the modern-day unit trust.  I have previously written about Unit Trusts being over 90 years old and although they have come a long way, they have not progressed as fast as they need to, and they need to step aside as a collective medium for investment.  Step up, step forward the ETF – the rightful heir.

There are thousands of ETFs covering all sorts of investment propositions, and many operate with underlying instruments that you just cannot get in unit trust form due to legislative constraints. There is even scope to access levered products for instance. In the last decade, how many new UTs have been launched versus the number of ETFs?  That alone should tell you that ETFs are the future.

ETFs have the ability to be actively managed, although to date they have generally been presented in the form of index or smartbeta offering.  At the end of the day (although that isn’t exactly the correct use of the term in this regard), if you can buy a collective fund in the form of an index ETF that is constantly priced throughout the day (“dynamically priced” as someone said to me recently) then surely you can dynamically price a Unit Trust.

Unit Trusts price once a day. Why?  Because they are 90 years old and haven’t moved with the times. Technology exists to allow for real-time pricing yet the UT industry steadfastly remains stubborn. Markets can move quite significantly between the valuation point (although most groups are priced at midday, there are different pricing points from different groups) and this can throw off lots of quirks for the pricing of our fund of funds portfolios. There are situations when you can be two or three days behind the market. For example, a midday price for a UT that invests along the lines of the MSCI World prices roughly half of the fund before the market opens (because this amount is in the US) and with roughly 10% in Asia you are paying the closing prices. Europe is open and you are paying midday prices of a market that is regularly priced off the expectations of what is happening in the US. Madness.

On top of that, do I really still need to wait 4 days to either pay for a purchase or receive proceeds from a sale of a Unit Trust when an ETF can do it over SETS and everything is settled much more quickly? Also, do I know what price I am getting when I send a purchase or redemption request at 9am? Nope – I have to wait until midday for the strike price to be set, and then in reality another 4 or 5 hours until I actually know the price. As a fund of funds manager, when dealing on behalf of the unit trusts we manage, the account opening process and purchase of a Unit Trust can take up to 4 weeks (due to approval of prospectus, anti-money laundering procedures, wet signatures (in many cases) agencies being set up and so on) whereas dealing in an ETF is done immediately.

Why hasn’t the UT market moved with the times? Well, there are some arguments that changes have been made. In some circumstances we still have the bid/offer spread, but let’s also think about the single price, swinging single price, dilution levy potential and so on.  It makes investing quite difficult.  You buy an equity; you see a price, that’s the price you pay. That price incorporates supply and demand. UTs can apply levies depending on what other buyers and sellers are doing in the market so as to not unduly harm the other investors in the fund. But we as investors don’t know what that number is, what the levy would be and so on. 

Have these changes made things better?  The number of new “funds” offered to UK clients over the last 20 years or so have predominantly been in UCITS form – as driven by European regulation. But what now being as Brexit has happened? Back to a swathe of new launches of unit trusts, or maybe the use of active, dynamic priced ETFs?

The title of this piece was suggesting that ETFs are not the future. I both agree and disagree with this point. I disagree because of the way the intermediated market has grown up. It needs to change. One of the main reasons they haven’t gained as much traction in the advised market as they should is down to admin platforms. Admin platforms can handle ETFs, but model portfolios cannot. Many advisers outsource portfolio management to discretionary fund managers who in turn provide model portfolios as the solution as at the end of the day we all have to treat customers fairly. As discretionary managers, we are requested from advisers to have our models on platforms – it makes sense, but as discretionary managers, we are hamstrung by the ability of the platform (and regulation) which ultimately means we cannot invest whole of market.

ETFs (and Investment Trusts for that matter, and equities – basically anything that is on an exchange) cannot be used in a model portfolio due to costs – cost of dealing, cost of rebalancing, the inability to buy fractional shares and so on.

I have friends in the industry in the US. US platforms can handle fractional shares, they do not charge for trading. The technology exists but isn’t incorporated in the UK which is frustrating. Why?

In a post-EU world, the financial services profession needs to consider what is best for the client. ETFs, priced and on a recognised exchange can be sold globally. Unit Trusts can really only be sold in the UK. Global is a bigger market than the UK. This is a great opportunity for financial services, but it needs the whole of the profession to pull together. ETFs could possibly be the answer.

 

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