2015 was another big year for exchange traded and tracker funds. Currency-hedged products and factor-based ETF launches proliferated and costs continued to come down. We spent the year looking not only at new product ranges but also crunching the true cost of investing in passive products and asking tough questions about trackers.
Product launches - curry, computers and currency hedging
It is not worth rushing out to buy every new ETF, but some are definitely worth a look. One of the hottest areas of development (and one likely to remain important next year) came this year from currency-hedged products. Fund providers rushed to protect UK investors' returns from being ravaged by a weaker yen and a weaker euro.
In April, Lyxor and BlackRock both launched new products aimed at protecting investors against the weaker euro. Lyxor lauched the the Lyxor UCITS ETF Euro Stoxx 50 Monthly Hedged C-GBP (GBP) (MSEX) and Lyxor UCITS ETF Euro Stoxx 50 Monthly Hedged C-USD (USD) (MSEU). BlackRock brought out the iShares MSCI Europe ex-UK GBP Hedged UCITS ETF (EUXS) and iShares JPX Nikkei 400 EUR hedged UCITS ETF (NK4E). The latter ETF capitalised on one of 2014 and 2015’s most popular currency plays - a bet on a weakening yen and strengthening Japanese equities.
Later the month, Deutsche Asset Management joined in, bringing out db x-trackers JPX-Nikkei 400 UCITS ETF GBP hedged (DR) (XDNG). The index, launched in 2014 to great fanfare, has been a popular way to bet on improved corporate governance in Japan and sterling currency hedging was a compelling addition worth paying attention to. With the European Central Bank having launched a fresh round of QE and Japan's prime minister Shinzo Abe potentially heading the same way, this could be a trend worth keeping an eye on in 2016, too.
This year also brought the launch of two niche products that deserved a more sceptical eye. The new ETFs targeting Indian corporate bonds and cyber security companies are worthy of attention but come with health warnings. The LAM Sun Global ZyFin India Sovereign Bond UCITS ETF (CRRY) has exposure to just six of the most-traded corporate bonds on the Indian stock market and could be spicier than it looks. We thought the risk associated with it was high. Similarly, ETFS ISE Cyber Securities GO UCITS ETF (ISPY), the first European-listed ETF to offer exposure to the cyber security sector, demands steely nerves as exposure to hyped sectors with potentially stretched valuations brings with it high risks as well as high rewards.
Among the currency hedging and sector-based launches there were also some innovative and highly useful ETFs to consider adding to your portfolio. These included db x-trackers FTSE 100 Equal Weight ETF (DR) (XFEW), the first ETF in the UK to give investors access to the equal-weighted FTSE 100 index and UBS Barclays MSCI US Liquid Corporate Sustainable UCITS ETF (UC98), the first ETF ever to offer exposure to fixed-income assets selected by environmental, social and governance records.
The industry changes you need to know about
Two consistently controversial topics in the world of ETFs have been stock lending and physically replicating vs. synthetically replicating ETFs. Synthetic products, which do not buy the assets they hold, have been waning in popularity in recent years and this year HSBC Invest Direct took all synthetic ETFs off its platform. It adds to an important recent trend whereby brokers and platforms have been designating synthetic ETFs as complex products. Fund providers such as Lyxor and Deutsche Bank have also been reducing the number of synthetic products on their books - last year Deutsche converted 30 of its synthetic ETFs to physical replication.
Meanwhile, iShares removed its stock lending limit in a controversial about-turn on a 2012 decision. ETF providers often loan out the assets they hold to a third-party in exchange for a fee, but the process has come under the spotlight from those who worry about the associated risk. Most providers have been restricting the practice and in 2012 iShares put a 50 per cent limit on the quantity of assets it was willing to lend. But this year BlackRock argued customer demand had prompted it to rethink and scrapped that limit entirely.
Low-volatility ETFs proved they were worth it
The massive market crash in August 2015 proved the perfect time to analyse whether ETFs designed to deliver less volatile returns were actually doing their job. It turned out they were, with the five low-volatility sterling ETFs listed on the London Stock Exchange proving less volatile than their plain vanilla counterparts between July and September. The peak to trough falls experienced by the European, global and FTSE ETFs all came in lower for the ETFs designed to offer less volatile returns than their originals, proving volatility to be one factor worth paying for.
That wasn't always the case. When we looked at the figures back in February, not all the minimum-volatility ETFs had been working well. For example, the iShares MSCI World Minimum Volatility ETF had a bad year in 2013 when it came to beating its non volatility adjusted ETF, posting a worse maximum drawdown figure of 5.94 compared with 4.12 for the MSCI World ETF and a higher volatility figure of 13.58 per cent compared with 11.75 per cent for the iShares World product. It looks as though the ETF may now have found its groove.
Passive funds on top? Rankings and ratings in 2015
The year also saw a proliferation of new ratings systems and rankings for tracker funds and ETFs. In October the Share Centre brought out a list of recommended index tracker funds and BlackRock, Legal & General, Vanguard and HSBC all made the cut. Among the Share Centre's favoured low-risk funds were BlackRock Index-Linked Gilt Tracker D Acc (GB00B83RVT96) and Legal & General All Stocks Index Linked Gilt Index I Inc (GB00B84VDP04). When compared with similar ETFs, the Share Centre's medium-risk choice HSBC American Index (GB00B80QG615) beat the comparable iShares S&P 500 UCITs ETF (IUSA) over a five- and 10-year basis.
Earlier in the year, Square Mile Investment Consulting and Research launched its own list of recommended passive trackers, favouring low-cost funds to hold for the long term. An initial 46 funds were granted its R (recommended rating) and all those chosen had an annual management charge (AMC) under 0.3 per cent. They included BlackRock 100 UK Equity Tracker D Acc (GB00B7W4GQ69), at 0.07 per cent, Vanguard FTSE UK All Share Index A Acc GBP (GB00B3X7QG63) at 0.08 per cent and L&G US Index I Acc (GB00B0CNGN12).
In May, data company FE Trustnet also launched its own ranking system for passive funds, promising to be the first objective guide for comparing exchange traded funds. Instead of looking at the usual fund performance criteria, such as total return the system homed in on tracking error and tracking difference - the performance metrics crucial to passive funds. But experts said the rankings might not capture every cost, with liquidity being a tricky metric to pin down. The tool also attracted some criticism for failing to include smart-beta ETFs in its analysis.
ETF sectors to benefit from a US rate rise
One of the key investment themes from 2015 - likely to remain important this year - was the much-anticipated US interest rate rise. In September we looked at the ETFs likely to be affected. Those most affected will be concentrated in the fixed-income market, but emerging markets debt and equity funds also look likely to feel the pain from a rate rise due to high levels of dollar-denominated debt and the risk of capital flight from emerging economies back to the US with better return. To some extent, these themes will now be priced in, but investors holding ETFs such as iShares JPMorgan $ Emerging Markets Bond UCITS ETF (IEMB), which offers exposure to dollar-denominated emerging markets debt, and db x-trackers MSCI Emerging Markets Index UCITS ETF 1C GBP (XMEM) might have to keep an eye out.
We also tipped Source Financials S&P US Select Sector UCITS ETF (XLFQ) in a related bet on the outperformance of US financials in response to a hike. According to a Source report, US financials have outperformed in previous rate hike periods by a median 5 per cent annualised and did so in 71 per cent of cases - in five out of seven cycles. Banks are also the third cheapest sector in the US.
ETF price cuts in 2015
The price war in passive funds has been much documented and, although 2014 was the major year for price cuts, 2015 saw fees slashed too. Vanguard removed its dilution levy - an initial charge - from its LifeStrategy fund range. It had amounted to 0.1 per cent of investment and meant that all five funds in the suite, ranging from 20 per cent to 100 per cent equities, now cost 24 basis points.
At iShares, the most recent price cuts were to the iShares Nikkei 400 EUR-hedged UCITS ETF (NK4E), cut from 0.45 per cent to 0.25 per cent ongoing charge, the iShares FTSE 100 UCITS ETF (Acc) (CUKX), which moved from 0.10 per cent to 0.07 per cent and to the iShares Core FTSE 100 UCITS ETF (ISF), also cut from 0.10 per cent to 0.07 per cent.
Deutsche Bank reduced the fees on its db x-trackers Harvest CSI300 Index UCITS ETF (ASHR) from 1.1 per cent to 0.65 per cent. Simon Klein, Deutsche AWM's head of exchange traded product sales for Europe, Middle East and Africa, says: "The big year for ETF management fee cuts was 2014 when a number of providers cut their fees. We introduced a range of db x-trackers core ETFs that year, with annual all-in fees starting at 0.07 per cent a year for major equity benchmark exposures. There has been far less fee cutting activity in 2015. I think for physical replication ETFs fees have hit a natural floor for many exposures, so we’re unlikely to see headline-grabbing fee cuts in 2016.
"Low management fees are only one aspect of how ETF providers compete to offer the best value ETFs. For us, we aim to get the overall cost of ownership, which includes important cost factors as the spread the ETF trades at on exchange as well as management fees, as low as possible."
Don't forget to check in too with our two model ETF portfolios. We have one for growth and one for income and check up on them regularly to see how they are doing.
