Exchange traded funds (ETFs) are now routinely used by multi-managers and funds of funds, and their qualities are harnessed for a multitude of almost contrary applications. For instance, they are used to provide access to illiquid assets such as commodities and other alternatives but they are also often the choice for assets in the more efficient, developed markets where active management may not add value. Their low cost means they are useful for frequent tactical trading and transition management, but it also makes them suitable for long-term core positions. They are used to take alpha bets but they are also often used simply to hedge existing portfolio positions.
“There is an increasing trend in multi-manager and funds of funds to use ETFs both to complement existing holdings and to replace traditional holdings,” says Claus Hein, head of Lyxor ETF in the UK. “Multi-managers in general realise ETFs are very liquid implementation tools and very competitively priced and they can add asset classes such as developed markets, emerging market equities, fixed interest and inflation-linked bonds and commodities in a very flexible way.”
Even diehard active multi-managers such as Skandia are now considering ETFs. “ETFs are currently under discussion as there are more and more funds to choose from, and they would definitely help us implement different views on different asset classes,” says Ryan Hughes, senior fund manager at Skandia Investment Group. “We’re an active house so I would not expect to use them as a straightforward equity replacement but for direct exposure to commodities and currencies.”
In the current climate, ETFs are increasingly used a place to park funds while a manager waits for visibility to improve. “We see ETFs used for two main purposes,” says Mr Hein. “As the core position in actively managed funds that gives exposure to developed or global equities, but also if a multimanager is not pleased with the performance of an active manager and is considering leaving a fund and reallocating to another vehicle, then he may use an ETF as an effective transitioning tool, exposing the portfolio to the same benchmark, as he unwinds the position. Or he may park cash into an ETF to keep exposure to a particular market if can’t identify a suitable strategy.”
For managers experience difficulty in calling the market, or in finding consistently outperforming active managers, ETFs are now seen as a credible holding strategy.
Philip Philippedes, head of institutional sales at iShares, agrees that investors increasingly use ETFs tactically to maintain a presence in a market. “Perhaps they know they have a good manager, but the asset class is not performing well, so rather than search for a new manager, they may invest in an ETF and wait until the manager recovers,” he says.
“ETFs offering the more exotic and thematic exposures may be particularly appealing in asset classes where it is hard to find a manager with a good long-term track record,” adds Mr Philippedes.
A perfect blend
There is a growing belief that blending active and passive is the optimal way to structure a portfolio, and active risk can then be dialled up and down.
“Multi-managers are taking it upon themselves when to go active and when passive,” he explains. “A few years ago, multi-managers tended to focus on good active managers but as the active/passive debate strengthened with the volatility in the market, a lot of managers are buying passive while they find a manager who can make alpha and has a performance track record.
“Multi-managers and multi-asset class fund managers look after both the asset allocation and the manager selection and some are trying to decouple the asset two,” says Mr Philippedes. “So for example if they want to retain the asset allocation but the manager is not performing or has a high tracking error, then they can assign more to passive exposures to ride out that volatility. If a multi-manager has allocated money to a certain exposure and is performing poorly, an option they have is to top up the asset allocation with a relevant ETF, parking money on an interim basis and then reviewing the manager later.”
One of ETFs’ strengths is that they are, as the name says, exchange traded, which is so much easier than opening an array of unit trust accounts. “The fact that an ETF settles like a share makes it very powerful,” says Charles Morris, a director of HSBC Global Asset Management who manages an Absolute Return fund. “If a fund manager buys a unit trust then it will have to open an account with that manager and carry out the necessary due diligence. But if he invests in an ETF, he is entering into a market based transaction.”
