If you want to invest in niche areas of the stock market, exchange traded funds (ETFs) can make great investments. But the ETF market is growing fast and providers, hungry for your money, are creating ones which track just about everything.
Interested in fishing? There's an ETF for that. Or what about the lithium industry? Well, there's an ETF for that, too. And one of the latest trends in the US is ETFs that invest purely in your local neighbourhood. For example, a company called Knight Capital Group run a Nashville ETF that only invests in companies based in Nashville. Sceptics believe this is just a marketing ploy and there is no UK equivalent yet as the US is well ahead of the UK when it comes to ETFs, although some experts are speculating a pure Scottish ETF could be on the cards in the future.
But experts warn that many of these ultra-niche products are nonsensical and not suitable for private investors because the risks are just too large.
However, there are some concentrated areas in which ETFs are very useful investment tools. Some can help you reach areas of the market which active funds don't cover, and others are able to beat actively managed funds covering the same sector, at a fraction of the cost.
Using an ETF could be a good idea if you want to invest in the following niche areas.
Single countries
There are ETFs tracking virtually every country. Active mangers struggle to invest in some countries in developing markets where backhanders are commonplace, making it hard to do business. But tracking an index, especially when the ETF gets its returns via derivative swaps rather than buying individual shares, makes things a lot easier and can reduce tracking error. Peter Sleep, senior portfolio manager at Seven Investment Management, adds that ETFs also make life a lot easier for investors as they do not have to negotiate some of the foreign tax issues.
One country that has seen a particular pick up in interest recently is Turkey. The economy has grown exponentially since its last financial crash and it has many western characteristics because of its ties to Europe. However, Turkey has a trade deficit and is a very risky play for your portfolio. For this reason it's definitely not a core holding but could account for a small part of your portfolio if you've got a high-risk appetite.
There are no Turkey equity investment trusts, or Turkey equity unit trusts or open-ended investment companies (Oeics) domiciled in the UK, but there are a number Turkey ETFs listed on the London Stock Exchange. These include HSBC MSCI Turkey ETF (HTRY), which has a total expense ratio (TER) of 0.6, and iShares MSCI Turkey UCITS ETF (ITKY) with a 0.74 per cent TER.
Bonds
ETFs are also good for offering access to very specific sections of the bond market, including areas where it is difficult to add value such as gilts. Some investors like gilts because they consider them a safe asset, and short-term bonds are less responsive to interest rate changes. But active fund managers find it difficult to add value here and many active funds in this area tend to underperform. But iShares UK Gilts 0-5yr UCITS ETF (IGLS) covers this narrow area, tracking 14 different bond issues with an average maturity of 2.64 years. It's TER is very reasonable at 0.2 per cent.
Global financials
There are active funds purely focused on financial stocks but ETFs can be a better way to get access. Financial stocks are a very diverse area, with everything from commercial banks to insurance companies and asset managers, making this sector unpredictable. Active managers take long-term calls on certain shares but some investors prefer not to hedge their bets by holding the whole index.
Emerging markets bank stocks are also an area of interest for some investors, but there are no actively managed funds in the UK that invest solely in these.
Adam Laird, passive investment manager at Hargreaves Lansdown, says it's an exciting sector because there are far fewer people with bank accounts in emerging markets than the developed world. So as the retail banking sector expands it will become more innovative.
IC Top 100 Fund Jupiter Financial Opportunities (GB0004790191) has underperformed in recent years, a reason why Hargreaves Lansdown removed it from its list of preferred funds. Since 2011, Philip Gibbs has also not been involved with the running of this fund. While he was sole manager between the fund's launch in 1997 and October 2010, it returned 766 per cent compared with 51 per cent for the FTSE Financials Index.
db X-trackers MSCI EM Financials Index UCITS ETF (XMEF) has UK reporting status and a reasonable TER of 0.65 per cent, but it doesn't pay dividends, instead it reinvests them.
Mr Laird also likes Amundi ETF MSCI Europe Banks UCITS (CB5) and Amundi ETF MSCI World Financials UCITS (CWF) because they are lower cost than their rivals, with respective TERs of 0.25 per cent and 0.35 per cent.
