ETFs: versatility and liquidity at low cost
29 November 2018 | Topical insights
Exchange-traded funds (ETFs) have become the vehicle of choice for many investors and the huge growth of the industry in recent years is showing no signs of abating.
Offering liquidity, transparency, and low costs, ETFs are shaking up traditional distribution channels, disrupting the industry for the benefit of investors.
In this video interview, Vanguard international division managing director Jim Norris speaks to Bloomberg about the compelling case for ETFs going forward.
One of the biggest advantages of ETFs is their flexibility, and Norris explores the range of ETF strategies available, as well as the different ways investors can make the most of them. From core portfolio allocation instruments to tactical adjustment tools, he explains how ETFs are cost-effective, easily accessible products that can benefit investors of all sizes.
He also examines the scope for further growth in indexing and ETF assets and looks at how the ETF structure can provide liquidity even during periods of market volatility.
This video is directed at professional investors only (as defined under the MiFID II Directive) investing for their own account (including management companies (fund of funds) and professional clients investing on behalf of their discretionary clients). Not to be distributed to the public. The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.
Start of transcript
Why are ETFs the best vehicle for index investing?
Mr. Norris: They’re highly liquid, highly transparent. Tim [Buckley, Vanguard CEO] talked about being low cost. I describe it often as, in most markets around the world, the distribution environment is quite captive. It usually requires commissions and retrocessions, so we always see ETFs as a way to sort of drive a wedge into those channels. You can stop somebody from buying a fund if it’s not on a platform, but you can’t stop them from buying an ETF.
Also, easily it can be cross-listed into multiple jurisdictions; it can be easily purchased cross-border; you can actually take an ETF and wrap it into a locally domiciled type product. So the flexibility, I think, provided by the ETF for retail investors is pretty compelling.
And then on the institutional side, you’re beginning to see now ETFs being used by asset managers, hedge funds, others. If they want to really get sort of cheap, quick exposures; it could be by geography; it could be by sector; it could be by factor.
And then, frankly, just from a liquidity perspective, there used to be a lot of managers who, let’s say, would have used futures to equitise their cash. [Now they] are able to use ETFs, often more efficiently. So there are a lot of structural elements that I think make it a pretty compelling product offer.
How do you address the criticism that ETFs are getting too big?
Mr. Norris: When you think about indexing overall, [it] is roughly fifteen percent of all of the AUM on the equity side – it’s probably five percent on the fixed income side – and then ETFs are a sub-set of that. And actually today, despite their growth, they’re still a pretty small sub-set of that.
So, one, indexing as a category is pretty small relative to what happens in active. You know, the individual size of any ETF – and obviously each ETF is an individual portfolio. And interestingly enough, although there’s always the worry of what happens when there’s a market downturn, you know, people running for the exits, but when we look back over quite a few examples we had of crises over the past twenty years, from the tech bubble in ’99, the GFC [in] 2008, we just haven’t seen the kind of behaviour that people worry about.
And then the last thing I would just say is, much like a stock, the premise of a stock is liquidity, and actually ETFs are delivering on that liquidity. You may not like the price that you get, but you’ll get a price. You know, it’s a closed – so when people talk about everyone selling, well obviously that’s not true; if everyone’s selling then everyone’s buying, and so we actually think that the fluidity and liquidity of the ETFs is pretty compelling.
I will say, when you start getting into some very niche ETFs, when you get into some of these fairly complex ETFs – leveraged, 130/30 – I think that’s a whole different ballgame. But I don’t think that’s about the ETF structure; I think that’s about the investment strategy that I think could be concerning, particularly in periods of volatility.
What are the advantages of passive investing in times of low volatility and more recently, high volatility?
Mr. Norris: Well look, as it relates to volatility, we would say no; if you’re a long-term investor, what’s happening today in the financial markets, or frankly even this year in the financial markets, isn’t really all that relevant. Now, the argument for active management twenty years ago was that, hey look, passive management in a bull market works because you’re just buying the market on the way up, but when there’s volatility or when the markets go down, that’s when active managers are going to outperform, and of course that hasn’t happened.
You know, whether the markets are going up or the markets are going down, it’s a zero-sum game. The only way that you could argue an active manager would do better on the way down, is if they’re moving to cash, right? They’re making a bet that the market’s going down. They’re going to move out of equities, but again if you’re an investor who’s hiring an active manager, you’re not hiring them to make asset allocation calls. You’re certainly not paying them a high management fee to have your money sitting in cash. So, look, if you’re a long-term investor, it just shouldn’t matter.
If more investors start to use ETFs, is there a point in which active investing becomes a better bet?
Mr. Norris: Yes. There should be an equilibrium point, right? I mean, it’s sort of an existential argument or question to sort of ponder, but it’s hard to fathom, well, if a hundred percent of the money is index, well then clearly there ought to be ample opportunities for active managers through price discovery to be able to outperform.
I’d say, again, globally it’s fifteen percent of AUM; we’re a long way I think from whatever that equilibrium point is going to be. Look, we always say it’s not active versus passive. We’re a significant active manager actually. If active managers lower their fees substantially, they’ll do better; they’ll outperform. And it’s really difficult to be charging the same asset management fees in an environment where the alpha opportunity is three, four hundred basis points, which was twenty years ago; today in most markets that alpha opportunity is a hundred basis points, maybe a hundred and fifty basis points. You can’t charge the same fee when the opportunity’s four hundred as when the opportunity’s one hundred. Lower fees, active management will do better.
Investment risk information:
The value of investments, and the income from them, may fall or rise and investors may get back less than they invested. Past performance is not a reliable indicator of future results.
Other important information:
This video is directed at professional investors only (as defined under the MiFID II Directive) investing for their own account (including management companies (fund of funds) and professional clients investing on behalf of their discretionary clients). Not to be distributed to the public.
It is for educational purposes only.
The material contained in this video is not to be regarded as an offer to buy or sell or the solicitation of any offer to buy or sell securities in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so.
The information in this video does not constitute legal, tax, or investment advice. You must not, therefore, rely on the content of this video when making any investment decisions.
The opinions expressed in this video are those of individual authors and may not be representative of Vanguard Asset Management, Limited.
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