ETFs do this by tracking standard indices, as well as benchmarks that incorporate factor tilts in a bid to replicate the investment strategies pursued by active managers (that is, strategic – also known as ‘smart’ – beta). There is also a growing number of ETFs that incorporate currency hedges to address the issue of foreign exchange volatility. Meanwhile, in the realm of fixed income, it is possible to buy products with in-built interest rate hedges that aim to shield returns from the variations in the monetary policy cycle.
It is this remarkable level of choice in terms of market exposure – not to mention the low-cost nature of the vehicle – that makes ETFs so appealing to investors, and in particular, investment portfolio builders.
At this stage, ETFs in Europe are mostly used by institutional investors. Their usage within portfolios is varied and very frequently in tandem with actively-managed funds. Some investors take strategic buy-and-hold positions on common market exposures (for example, UK or US large-cap equities) in a clear bid to cut portfolio maintenance costs, while others prefer to focus on the ETFs’ ability to offer very finely-tuned exposures in order to meet short-term tactical asset allocation needs. Increasingly, ETFs are also being used as substitutes to futures for cashflow management purposes as the latter suffer from a distinct lack of truly liquid contracts.
Nowadays it is perfectly feasible to build comprehensive investment portfolios entirely with ETFs. In fact, a number of practitioners in the UK are already doing so, offering low-cost pre-packaged solutions to suit the varying needs of investors. At a time when the government is asking us all to take increased responsibility for our finances – in particular as it pertains to funding our retirement – the lure of low-cost comprehensive investment solutions such as ETF managed portfolios can only be expected to grow. In fact, this could be instrumental in spreading the use of ETFs among the European retail investor community, which, by contrast to their US counterpart, remains largely unaware of the existence of these financial products.
Jose Garcia-Zarate is senior ETF analyst of Morningstar Europe
