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Baillie Gifford: ETFs are for Suckers

Monks trust manager Charles Plowden says passive funds are “non-thinking money” and investors “have forgotten their role in the economic chain”

Holly Black 23 October, 2017 | 7:30AM

Investors using exchange traded funds and index trackers are “the next bunch of suckers”, says one fund manager. Charles Plowden, manager of the £1.6 billion Monks Investment Trust (MNKS) has likened the rise of passive investments to the opaque mortgage products which contributed to the financial crisis.

The veteran manager, who has worked at Baillie Gifford since 1983, says passives are “non-thinking money” and investors “have forgotten their role in the economic chain”.

“The move to passive investments is not investing, it is blindly following statistical constructs. Traders aren’t creating, building or nurturing anything and that is what is investing is,” says Plowden.

ETFs have risen sharply in popularity in recent years, as rising stock markets have made it easy for such products to outperform simply by copying the performance of an index. Over the past five years the FTSE 100 has climbed more than 30% from 5806 to 7543, while the S&P 500 is up more than 80% from 1412 to 2562.

Research from Seven Investment Management shows the amount held in ETFs globally has grown from $500 billion in 2005 to almost $5 trillion today. And UK investors have a further £159 billion in tracker funds too, according to latest Investment Association data.

There are now more than 7,000 exchange-traded funds available from more than 300 providers. Research by Baillie Gifford shows there are now more indices tracking the US stock market than there are companies listed on it.

But some experts say that investors opting for passives are setting themselves up for problems in the future.

“[The move to passives] reminds me of the Collateralised Debt Obligation products before the financial crisis,” says Plowden. “All those mortgages were packaged up and sold to people as safe investments when they didn’t know what was in the package. That’s the thing it most closely resembles to me – and look at how that ended.”

So-called CDOs were widely blamed for the collapse of the financial system in 2007. Investors bought packages of mortgage debt which they believed to be of investment-grade quality. In fact, many were sub-prime mortgages which went on to default.

“It’s probably the same clever bankers creating these products. They’ve found a new bunch of suckers to sucker,” says Plowden.

Should Investors Prepare for the Crash?

Investors who have tracked the FTSE 100 or S&P 500 over the past five years have enjoyed substantial returns – both indices have reached new record highs in the past week alone.

But as stock markets continue to climb there are concerns about how investors will be affected in the event of a correction. In particular, there are fears about stock markets will react as central banks stop pumping money into the economy through quantitative easing and start to hike interest rates.

Plowden says: “It’s like if everyone put on a blindfold and ran forward at the same pace. It’s fine until someone falls and then it’s like dominoes and everyone falls down – that’s what happened to those mortgage investments. The more people who invest with their eyes closed the more dangerous it becomes to do so.”

But the fund manager says fear of a stock market crash won’t change his approach to investing. While index investors may be hurt by a market correction, a short-term market move doesn’t affect those with a longer time horizon.

“We’ve already seen it in mini-form through flash crashes. People say it’s terrible when these crashes happen, but that’s only true if you’re a trader or if you’re highly geared. For us, it just distorts prices for a couple of days,” he says.

Instead, Plowden is looking forward to the next market correction so he can take the opportunity to increase the level of gearing of the fund, currently 6%, and buy shares at a discount.

The Morningstar Bronze-rated trust, which was launched in 1929, focuses on companies which have the potential to double their value every five years. Plowden prefers those which invest some of their earnings back into the business rather than giving everything back to shareholders.

Some 43% of the portfolio is in US businesses including Amazon (AMZN) and Royal Caribbean Cruises (RCL) and a further 22% in emerging markets stocks such as Alibaba (BABA).

Morningstar analyst Fatima Khizou says investors in the four-star rated fund “who stay for the long-haul should be well rewarded” and also points out that its ongoing charges are among the cheapest of all global equity funds.

And while Plowden doesn’t think share prices are in bubble territory, he is ready to take advantage of the opportunity should there be a fall.

He says: “I’m not saying it’s all definitely going to go wrong, but it feels really worrying to me. When lots of people do the same thing at the same time, it creates problems.”

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Securities Mentioned in Article
Security NamePriceChange (%)Morningstar
Alibaba Group Holding Ltd ADR181.20 USD-1.87 Inc1,495.55 USD-3.20
Monks Ord758.00 GBX-2.07
Royal Caribbean Cruises Ltd117.04 USD-2.61
About Author

Holly Black  is a freelance journalist specialising in investments and personal finance