Apologies but I’m still stuck in my post-Boglephase, this time with a focus on ETFs. Jack Bogle famously disliked ETFs of course, thinking that they ended up being much too tactical. He worried that they encouraged short term thinking and allowed product issuers to increase costs by coming up with some daft unique investment strategy which involved impossibly complex algos and detailed data scraping.
I’m not sure that Bogle was entirely right on this score and the growing proliferation of low cost robos and multi fund managers who make extensive use ETFs speaks to their value for long term investing. I’d also suggest that Bogle would have been thrilled by the emergence of platforms which make a great play on ETFs such as Freetrade which I recently signed up to. Apparently, before Christmas, I was number 74,302 on a long waiting list for this new online app but within a few days of the New year, I’d suddenly been promoted to full customer. What happened to other 74,302 in the long line?
Anyway, the point here is that Freetrade has a short but promising list of ETFs which can be bought at zero fee through its platform. For the long term investor this a manna from heaven. One could easily construct a simple portfolio of cheap ETFs, say 4 to 6, and then buy them through Freetrade and keep the overall portfolio cost below 25 basis points (including the fund TER and possible bid offer spreads). This is exactly what Bogle would have loved although it also presents something of a challenge to the Vanguard model over the long term.
Back in the mainstream where Vanguard increasingly dominate, we’ve seen intense competition in the multi funds passive space hot up – the subject of my Citywire column next week.
The choice of multi managers is growing all the time and by and large, they are compelling value. But I also have a hunch that the adventurous private investor could simply track the biggest and best players in this space and then work out what’s inside each of their portfolios. Average out the variations in asset classes, and then build a sensible asset class list and build your own portfolio using a service like Freetrade.
But one issue immediately presents itself. Once one has decided on the broad asset class building blocks (say 20% in US equities, 30% in emerging markets), which ETF to use? The lazy answer is to choose the biggest by AuM or the cheapest by TCO/TER. This is not a bad first step, but I think the selection process needs to be a bit more rigorous than that. For the Citywire article, I talked to Matt Brennan at AJ Bell. He suggested that investors should also look at the following list of variables:
- Does the ETF physically replicate the index or is it using swaps and derivatives
- Does the ETF undertake stock lending
- How big is the ETF
- How well has the ETF tracked its index over time
- How diversified is the underlying index
- Trading costs such as bid/ask spreads
- How often it rebalances
- If the ETF is trading at a premium or discount
And then there’s the tricky issue of the index itself. As Brennan at AJ Bell reminds us, not all indices covering the same asset class, are alike. According to Brennan “in reality, the index providers themselves such as FTSE or MSCI make discretionary decisions as to which countries count as emerging markets or not. MSCI include South Korea as an Emerging Market, whereas FTSE counts it is a Developed market. This means that the iShares ETF, tracking the MSCI product has a 3% weight to Samsung, and the Vanguard product (tracking FTSE) has a 0% weight”. Quite.
Which brings nicely back to Jack Bogle. My sense is that he’d have been deeply worried by the profusion of indices and the accompanying new-fangled strategies. He was already deeply sceptical of stuff like smart beta – or dumb beta as he once called it. I think he’d have also told investors to really get under the skin of the index they are tracking. Download the fact sheet and compare it with other providers and then work out which index is right for you. Indices really, really matter.