Sofat: Use a Passive Approach to Invest in Mainstream Markets

"We think it's pretty difficult to beat the market, so certainly in the mainstream markets we'll be using a passive approach."

Alastair Kellett: My name is Alastair Kellett. I am part of the ETF group here at Morningstar. I am joined this morning by Anna Sofat, founder of Addidi Wealth, to talk about the roll that exchange-traded products play in her clients' portfolios. 

Good morning Anna. Thanks for joining us. 

Anna Sofat: Good morning. Thank you. 

Kellett: First off, can you tell us a bit about your company? 

Sofat: Addidi Wealth is a financial services boutique mostly for women and their partners and families. And we like to think we do things slightly different. So, our key proposition if you like is to help clients create wealth, invest it and to enjoy it. So, those are our three key themes if you like around wealth. 

Kellett: And in what proportion of your clients' portfolios, would you say you use passive investment strategies? 

Sofat: I supposewe're on a cusp of probably a major change. So, historically, I would say it might range from nil to 50%-60%, and perhaps a little bit more. Over the years, we are increasingly using a passive approach to investing. Going forward, we're going to be pretty much a passive business. 

We've just been reviewing our investment proposition over the last few months and doing a lot of research around what we believe in and what we don't believe in, what we like, what we don't like and I suppose the long and short is that we think it's pretty difficult to beat the market, so certainly in the mainstream markets we'll be using a passive approach. 

Kellett: Philosophically, do you think that it works better for the core building blocks of a portfolio or more for the satellite areas? 

Sofat: Interesting really, because initially I used to think that for the main markets actually you can get active managers who outperform, and perhaps for the more specialist markets where the risk was higher perhaps [it’s] better to follow a passive. 

And I've just done a whole [360] turn really so that I think the broad markets like America and Europe and UK, I think it's very difficult to beat the markets. You do have some managers [who can], but it's very difficult to do that. So, typically, we go for low-cost passive funds. 

Kellett: Does that apply across asset classes, as well? 

Sofat: Yes. Yes and I think one of the good things, I suppose, is as use of passive funds increases, the choice is getting better. I think in America it’s much wider than we have it over here, but we are beginning to see choice in fixed interest now, which is good. And even in property, which is good as well. So, yes, and equities of course is pretty mainstream. 

Kellett: When it comes to passive investing, in which cases do you prefer to use exchange-traded products as opposed to, say, index funds? 

Sofat: I think it really boils down to what they can provide opposed to a passive fund. 

Kellett: What do you see as the benefits of exchange-traded products for your clients? 

Sofat: I mean, I suppose typically they are around low costs. Not all passive funds are low cost. There are a few investment houses that focus on low cost, but actually some passive funds are quite expensive and some of them are more expensive than actively managed funds. In which case, I don't see the benefit of using a passive approach, full stop. 

So, in those scenarios, we look at exchange-traded funds to provide, for one, low cost and to provide, I suppose, fine-tuning of certain strategies, certain areas that we want exposure to. And they may be as broad as the FTSE All Share [index] to being emerging markets. So it really just depends. 

We have set criteria that we measure funds on. And the two key ones are around cost and tracking errors, because if you are going for passives then you want to make sure you're following the index quite faithfully. 

Kellett: The FSA recently published a factsheet for investment advisers to raise awareness of the risks in exchange-traded products. What are the key areas you consider when assessing the risks of exchange-traded products? 

Sofat: Probably not dissimilar to the risk that I suppose the FSA has highlighted. So we go through a due diligence process on the business that we think, right, there are going to be several ETFs—or even one ETF—that we want to use from them as well as the ETF itself. 

So, we look at whether they're physical or synthetic. We tend to prefer physical. And we look at the security lending programme and where that is, and how it's constructed and what happened in 2008, for example, when things went a bit haywire. We look at obviously counterparty risks within that and we look at also the parties that make up the marketplace, the participants if you like, as to how many market makers are involved within certain ETFs, because that dictates how liquid it is for you to get in and out of that. 

So, those are probably really the key areas that we look at. Obviously, regulation as to where they’re domiciled because that impacts on how comfortable we are with investor protection overall. So, we tend to prefer to be Luxemburg or Dublin domiciled on the whole. 

Kellett: Thanks very much Anna. That's all the time we have today. You can access our ETF analytical tools on Morningstar Adviser Workstation. You can also read more about these topics on Morningstar.co.uk.

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