Investors have poured cash into exchange traded products (ETPs) over the past decade. The low-cost tracker funds that are listed on the stock exchange gained popularity during the global recession, as volatile markets meant investors lost faith in active management.
Over the last year there have been several surprises in the ETP market. According to BlackRock’s ETP Landscape report ETPs listed in the US grew at a faster rate than in any other region and developed market equity flows drove industry growth. The Asia Pacific ETP market experienced similar growth to the US – despite the indices falling, and actively managed funds saw outflows. Latin America was the only region where assets declined.
Dodd Kittsley, head of BlackRock ETP research said: “The role of ETPs continues to grow in the global capital markets as investors seek efficient, tailored access to varied investment exposures and look for diversified buy-and-hold investment products.”
Here, Morningstar senior analyst for passive fund research Jose Garcia Zarate tells Emma Wall why ETPs have proved so popular and how investors can choose between the plethora of options on offer.
Transcript
Emma Wall: Hello, and welcome to the Morningstar series, Ask the Expert. I'm Emma Wall and here with me today to discuss ETFs is Jose Garcia Zarate. Hello, Jose.
Jose Garcia Zarate: Hello.
Wall: So recent study has shown that by next year the cash in ETFs may exceed the cash in hedge funds, which is pretty impressive. Why have the ETFs proved so popular over the last couple of years?
Zarate: I think it's not just over the last couple of years, it's really kind of like a revolution that's being going on in financial markets over the last decade actually, both in the United States and in Europe. This just basically goes down to two very simple things. One is that they are very cheap products compared to alternative investments there, and b, that they are fairly easy to understand. I mean they're just index trackers. They just happen to be traded on the exchange that's the added, you know, perhaps level of complexity, but at the end of the day they just basically track an index and they do it at cheap prices.
Wall: With all this choice in the market, I mean is it a case of the more choice, the better. How do I as an investor determine between a good ETF and a bad ETF?
Zarate: Well, that's perhaps where the problem actually begins for an investor, particularly for retail investors. You may end up with a lot of ETFs tracking the same index issued by different ETF providers. And it could be tricky for an investor to say okay, which one is the best, because at the end of the day they are tracking the same index.
Obviously, Morningstar can help you there, because we do a lot of research, independent research into the various ETFs available for investors in the marketplace. But if you don't have the ability to use Morningstar, I think you can discriminate fairly easy in terms of things like assets under management, the price, because it's not just – the price that you have to pay is not just the famous TER, the annual management fee and you have to buy this product on the exchange.
So, you have to perhaps make a broad assumption that products that are the most popular in terms of size will give you the best chance of a lower price in terms of bid-offer spread of example on the exchange.
Wall: Bearing those two qualities in mind and also this great phenomenon of the great rotation, moving from bonds into equities, two very popular indices at the moment, S&P 500 and FTSE, where would you go for that exposure?
Zarate: Let's start with the S&P 500, everybody wants to pile in into the success of the U.S. economy. I would probably go for the cheapest option out there. And the first thing that comes into my mind is the Vanguard S&P 500, which I think is selling for about 9 basis points. Of course, on top of that you have to add bid-offer spreads and brokers' commissions.
Wall: And for domestic exposure?
Zarate: Actually for domestic exposure, you would actually think that the FTSE 100 would be the obvious choice and there are quite a number of ETFs out there, that give you exposure to FTSE 100, but I would go for the FTSE 250. If you believe really in the story about the U.K. recovery, you want to benefit from – perhaps you want to get exposure to smaller and medium-sized companies rather than just the big international ones.
So thinking about the FTSE 250, one that comes on to my head is perhaps the HSBC FTSE 250, physically replicated. It's going to be a bit more expensive than the FTSE 100, but you get that exposure to smaller and medium-sized companies.
Wall: Jose, thank you very much.
Zarate: You're welcome.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
