Passive funds are generally lower cost than active funds, and this can make a significant difference to your investment returns – particularly over longer time periods. There is a wide variety of passive funds on offer, including simple index-tracking funds and exchange traded funds (ETFs), and exchange traded commodities (ETCs) which provide access to commodities. We have highlighted 10 passive funds for exposure to equities for growth, equities for income, fixed income, smart-beta strategies and commodities.
EQUITIES FOR GROWTH
SPDR MSCI World Small Cap UCITS ETF (WOSC)
Investors with longer time horizons and a stronger appetite for risk should consider an allocation to small-cap stocks, according to Dimitar Boyadzhiev, passive strategies research analyst at Morningstar. Unlike large and mature businesses, small companies can deliver substantial returns by introducing new products and capturing new markets.
“SPDR MSCI World Small Cap UCITS ETF is a one-stop shop for those seeking to add small companies to their Isa portfolios," says Mr Boyadzhiev. "One of the advantages of this ETF is its degree of diversification – it offers exposure to more than 4,300 small companies from 23 developed countries. Another advantage is its [relatively] low ongoing charge of 0.45 per cent, which guarantees that investors [in it] will keep more of the returns [they make].”
iShares Edge MSCI USA Value Factor UCITS ETF (IUVF)
This ETF tracks MSCI USA Value Index, which seeks to include stocks undervalued relative to their fundamentals. Alan Miller, chief investment officer at wealth manager SCM Direct, says: “This ETF offers investors exposure to both mid and large-cap companies on the US stock market – but without overvalued stocks."
This means it excludes large and arguably overvalued stocks such as Facebook (FB.), Amazon (AMZN:NSQ), Apple (AAPL:NSQ), Netflix (NFLX:NSQ) and Alphabet (GOOGL:NSQ), which owns search engine Google – the so-called FAANGs.
"This ETF screens stocks on three equally weighted indicators: forward price/earnings (PE), price-to-book and enterprise value to cash flow," continues Mr Miller. "This leaves it with a PE ratio that is 54 per cent lower than the commonly held S&P 500 market capital-weighted index.”
The fund holds 148 stocks and has an ongoing charge of 0.2 per cent.
EQUITIES FOR INCOME
Vanguard FTSE UK Equity Income Index (GB00B5B74684)
Investors seeking a yield and broad exposure to the UK stock market can get this via a UK equity income fund. Nicholas Astley, investment manager at Progeny Asset Management, suggests Vanguard FTSE UK Equity Income Index. This fund has low tracking error – delivers returns close to those of FTSE UK Equity Income Index – and invests in more than 100 companies, which helps to diversify risk. This unlisted fund – unlike some ETFs – holds shares in the index it tracks rather than replicating the returns using derivatives, which makes it less risky. The fund has an ongoing charge of 0.14 per cent.
Schroder US Equity Income Maximiser (GB00BYP25813)
This fund aims for an income of 5 per cent per year by investing at least 80 per cent of its assets in a passively managed portfolio of the top 500 listed US companies, by market capitalisation. But it also sells call options on the stocks – the right to purchase them at a specific price. “This means giving away some of the potential upside of the stock in exchange for a premium,” explains Ben Seager-Scott, head of multi-asset funds at Tilney Group. “In an efficient market, you should effectively be converting capital gain to income, but this depends on technical factors such as the relationship between implied and realised volatility, which has resulted in a performance drag of late."
However, this strategy has held up against other common US equity income investment strategies and resulted in an attractive yield.
FIXED INCOME
Vanguard USD Emerging Markets Government Bond UCITS ETF (VEMT)
With global government bond yields so low, in some cases negative, it is hard to justify some types of bond ETFs as an income investment. Rather, you can use them as a portfolio diversifier to mitigate the downside of more volatile investments when markets fall. But Matt Brennan, head of passive portfolios at broker AJ Bell, says you can still find reasonable yields – sometimes of over 4 per cent – on emerging market bonds.
“Although their yields are lower than in recent history, we see emerging market bonds as a better way to enhance yield than corporate bonds, where buying by pension funds and central banks has pushed prices up," explains Mr Brennan. "Emerging market bonds are higher risk than developed market bonds, but [the ones that] are denominated in US dollars still add some protection in equity market sell-offs."
Vanguard USD Emerging Markets Government Bond UCITS ETF has a relatively low ongoing charge of 0.25 per cent and assets of around £450m.
UBS JP Morgan USD EM Diversified Bond 1-5 UCITS ETF (UBXX)
This ETF provides exposure to emerging market sovereign, quasi-sovereign and corporate bonds, with a short-term maturity of between one and five years. Bonds issued by any one country cannot account for more than 3 per cent of the index it tracks – JP Morgan USD EM Diversified 3% capped 1-5 Year Bond – to reduce concentration risk. This index includes 858 bonds issued by 65 countries. The fund holds more than 600 fixed and floating-rate bonds.
Mr Miller says that “this ETF is well-spread and the currency exposure is hedged back into sterling".
The fund has a 12-month yield of 2.66 per cent and an ongoing charge of 0.47 per cent.
SMART BETA
iShares Edge MSCI World Minimum Volatility UCITS ETF (MINV)
Indices with smart-beta strategies weight the stocks they include according to investment styles such as value and quality, or market factors such as momentum and low volatility – rather than by market cap. This ETF tracks MSCI World Minimum Volatility Index, which is made up of stocks that are also included in the broader MSCI World index that have low absolute volatility, and low correlations to each other, to reduce volatility.
Mr Boyadzhiev says that this ETF is suitable for long-term but risk-averse equity investors who want to protect their portfolios from sudden market declines. “The fund’s considerable degree of diversification makes it suitable [for investors who do not want to hold many funds and is] tuned to mitigate downside risks.”
The ETF has an ongoing charge of 0.3 per cent.
SPDR S&P US Dividend Aristocrats UCITS ETF (USDV)
The overall yield of US equity indices is not high. For example, the S&P 500 index had a dividend yield of 1.88 per cent as of 31 January 2020. However, some individual US companies pay good levels of income and have outstanding long-term records of increasing them year after year. You can get exposure to these with SPDR S&P US Dividend Aristocrats UCITS ETF which tracks S&P High Yield Dividend Aristocrats Index, which is composed of stocks in the S&P Composite 1500 Index that have increased dividends every year for at least 20 consecutive years. These stocks have both capital growth and dividend income characteristics, as opposed to stocks that are pure yield or capital oriented. And the ETF has tracked this index well.
SPDR S&P US Dividend Aristocrats UCITS ETF could be a good way to diversify your sources income more cheaply than with active funds, as it has an ongoing charge of 0.35 per cent, albeit higher than those of plain vanilla US tracker funds.
COMMODITIES
Invesco Bloomberg Commodity UCITS ETF (CMOD)
Invesco Bloomberg Commodity UCITS ETF aims to replicate the performance of Bloomberg Commodity Index, after fees. This index is composed of futures contracts on up to 24 physical commodities, so provides a diversified exposure to these assets. The commodities included in the index are weighted two-thirds by liquidity and one-third by global production, with caps on individual and group weightings to ensure diversification. Bloomberg Commodity Index's composition at the end of January was 27.1 per cent energy, 23 per cent grains, 19 per cent precious metals, 17.5 per cent industrial metals, 7.6 per cent soft commodities and 5.9 per cent livestock.
Because the ETF does not physically hold the commodities it tracks, it has a swap fee of 0.15 per cent on top of its management fee of 0.19 per cent. But it has tracked its index well, and is large and liquid with assets of about £1.2bn.
Invesco Physical Gold ETC (SGLP)
Mr Brennan is tending to avoid commodities at the moment because in many cases they are trading above the cost of production. But he adds that commodities such as gold can help to protect portfolios when markets fall, and he likes Invesco Physical Gold ETC for getting exposure to this asset. "It is backed by physical gold held in vaults in London, and has significant assets of over £6bn," he says.
The ETC has an ongoing charge of 0.24 per cent.
