Investors are increasingly combining active and passive funds in their portfolios. Passive funds, such as exchange traded funds (ETFs), track market performance. They won't outperform but they can be considerably cheaper than active funds.
The trick is to identify the markets or assets where passive strategies work best. Here are some ideas for where to cut costs in your portfolio by using passive exchange traded funds.
For active trading in broad markets
When it comes to big markets such as the UK, Europe and the US, you're spoilt for choice when it comes to active funds. But when it comes to those that consistently beat the market there are fewer, although there's normally still a good selection from which you can choose.
For long-term investors - that means if you're saving up for something such as a pension or a house, for at least three years - you're probably best off with an actively managed fund. If you'd rather use a passive fund to track the index, you could probably find a tracker fund for a few basis points cheaper than the cheapest ETF.
But ETFs come in handy if you're making short-term trades in any of these markets. That means buying a fund with a view of holding it for less than three years. Timing the market isn't a tactic that's suitable for everyone as you need a lot of time and knowledge in order to be successful, but if you are a sophisticated investor with some time on your hands, ETFs could be very useful. For US exposure, try SPDR's S&P 500 ETF (SPX5). It has an very low total expense ratio (TER) of 0.15 per cent and comes from good pedigree, as State Street has a solid reputation for ETFs.
If you want to make a play on the UK recovery, a FTSE 250 ETF could be a good route into mid caps, which are currently faring well. Lyxor's ETF FTSE 250 (GBP) (L250) has a TER of 0.35 per cent and has been around since 2007, so it could be a good bet. However, it's worth noting the cheapest FTSE 250 tracker fund - the HSBC FTSE 250 Index fund - is slightly cheaper, with a TER of 0.27 per cent.
Gold
Investing in physical gold can be a bit of a faff. It can be tricky to store and a nightmare to sell. The simplest and cheapest way to get pure and direct exposure is via a gold exchange traded commodity (ETC).
There are a large number of actively managed commodity funds with high exposures to gold - but they tend to be invested in gold mining companies which often come with extra risks. Gold mining companies have proved volatile due to their exposure to the gold price. Unsuprisingly, most of them have performed appallingly this year, suffering huge losses due to the dip in gold price. If you buy a gold ETC you track the gold price directly, which is less risky than investing in companies related to gold.
This one of the best and most common uses of ETCs in private investors' portfolios, so here's a few we like.
■ ETFS Physical Gold ETC (PHAU) is designed to offer a simple, cost-efficient and secure way to access the gold market by providing a return equivalent to movements in the gold spot price less the relevant management fees. The ETC is backed by physical allocated metal held with its custodian, HSBC Bank. Each individual security has an effective entitlement to gold. It charges a management fee of 0.39 per cent and is eligible to be held in an Isa or a Sipp. Its base currency is US dollars, but there is also a sterling share class (PHGP).
■ If you want pure gold exposure without a link to the US dollar, have a look at db's Physical Gold GBP Hedged ETC (XGLS). Launched in April 2011, it is equipped with a currency hedging mechanism to minimise exchange rate risk, and it is backed by a direct investment in the underlying physical gold, stored in secure vaults in London. Each security entitles the holder to a specified quantity of gold. The fund has a management fee of 0.29 per cent a year plus a foreign exchange hedge fee of 0.4 per cent. This makes it more expensive than other non-hedged gold ETCs. However, if you want to minimise your exposure to the dollar, this looks like a good deal.
■ Source Physical Gold ETC (SGLD) is one of the cheapest products with a 0.29 per cent TER. It is one of the largest gold products listed in Europe, with over £1.2bn under management, making it very liquid, and therefore suitable for a long- or a short-term play. The fund won Best Exchange Traded Product for Gold Exposure at the IC Fund Awards 2013.
Gilts
Government index-linked bonds aren't exactly the most exciting investment, but they form a valuable, solid income base for many investors' portfolios. There are a limited number of actively managed funds to pick from in this sector, though, and often they struggle to outperform. Peter Sleep, ETF specialist at Seven Investment Management, says ETFs can be the best and cheapest way to buy gilts for private investors. He recommends the SPDR Barclays 15+ Year Gilt UCITS ETF and the SPDR Barclays Capital 1-5 Year Gilt ETF (GBP) (Ticker: GETS) and uses the latter in his own portfolio. "The shorter the duration, the less volatile the investment will be - and the whole point of owning gilts is to have a steady, reliable income stream," he says.
