UK Investors Favour ETFs for Value for Money

iShares' Joe Parkin says regulation and pressures on fees have driven investors into passive funds - and there is more cash to come for the ETF market

Emma Wall 29 November, 2017 | 10:42AM
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Emma Wall: Hello, and welcome to the Morningstar series, "Ask the Expert." I'm Emma Wall and I'm joined today by Joe Parkin, Head of UK Retail for iShares.

Hi, Joe.

Joe Parkin: Hi, Emma. How are you doing?

Wall: Good. Thank you. So, ETFs and trackers have long been used by institutional investors to gain access to markets at low cost. But increasingly, they are also being used by retail investors and the advisors that help manage their portfolios. What is it about ETFs and about trackers that is appealing now to this sector of the investible universe?

Parkin: Yeah, sure. I think there are several key themes that are at play here. The first one is regulation. And the increasing transparency has really put a focus on value for money and put index or trackers and active funds on a level playing field. The second thing, I think, as well is the banning of retrocessions or rebasing those revenue sharing agreements has again also helped them to be put on a level playing field. And I think the industry has become a lot more savvy around sort of active management fees and active managers who are charging active management fees but ultimately delivering the benchmark.

I think the second thing that's really interesting is the centralisation and outsourcing that we've seen happen, certainly, in the wealth management market. The centralisation is happening. More and more people are focusing on the asset allocation decisions and taking risk at that level and implementing with the best vehicle possible rather than focusing more on the fund selection thing. And the outsourcing thing is about margin pressure. You are outsourcing; you are creating an extra mouth to feed. It might put 30 bps on the overall cost. Where are you going to get that 30 bps from? I think you've seen that come out of the active management industry and move into the passive. So, that's where we see the shift of assets.

Wall: It used to be about this whole active versus passive, didn't it? You were either a fan of passive funds or you are a fan of the active fund manager. But increasingly, we are seeing individuals blend them together in their portfolios, aren't we?

Parkin: 100%. And we think that whole argument is just nonsenses. Every single decision or every single portfolio is ultimately active. Even decision to use a passive manager is an active decision. And so, I think, they can both stand-by-stand – or stand side-by-side in harmony and actually together deliver really good portfolios. I 100% believe that there is alpha to be had and there's always been alpha to have. I think that there's always been good years for stock pickers. What I think is missed is the fact that there has been this piece in the middle which has been charging active fees but hasn't been delivering active management. And I think that's the key change. But bringing the two together, I think, you get a very good portfolio.

Wall: And are there particular areas where we are seeing active being favoured and passive being favored? Because traditionally people thought of it as you build your portfolio with the core blocks, the sort of very liquid, very transparent industries such as, for example, US equities, that's where you go passive. And then you have this satellite approach with active funds, those more niche areas?

Parkin: I think there are certainly markets that are more efficient. But as I said, I think – I mean, one of the key themes we've seen this year is portfolio managers getting a lot more granular within those core markets. So, even when you said, okay, US equities, very hard to deliver alpha over a period of time, we've actually seen people start to break down that US equity exposure and invest in sectors and factors to deliver that.

I think about 90% of retail investors are comfortable with – according to the KPMG survey –about 90% are comfortable with equities. That then falls away slightly to 60% when you alk about bonds, ETFs or trackers. And then smart beta looks at about a third. So, I think, there is a comfort around equities and those core equity holdings as well as using them more dynamically. I think fixed income, there's still some growth opportunities as well as smart beta and factor investing, which I think is a really interesting evolution of the industry, and I think what's going to continue to drive the growth into indexing.

Wall: Which is going to lead me to my next question is, what is the future? Because quite often with investment we can look at how US has played out and sort of we can tell that Europe and the UK will follow that pattern. And in the US, there is a lot more use of passive funds. Do you think we've reached an equilibrium yet in the UK or should we expect passive take-up among individual investors to continue?

Parkin: So, our estimates, the estimates from KPMG and their recent survey is anywhere between 10% to 15% of portfolios in the UK are currently being held as passive. We think that's going to trend over the next three to five years towards 30% to 40% in that area and that's the result of the continued focus on regulation and transparency, a real focus on the value that advisors are delivering to their clients, the move to technology and I think also just the advent and the advancement of people addressing the advice gap and addressing lots of the cash that currently sits in bank accounts.

We estimate there's about $1.4 trillion sitting in cash and cash ISAs in the UK currently earning negative return if you take into account inflation. And I think there are going to be a series of the advances. At the moment, there's a few people playing in that digital wealth advice gap space, but I think more and more people are going to come to market, the retail banks, some really interesting people giving advisor's tools to lower the minimums they can possibly look at in their space.

So, I think, it's a really interesting time and I think the continued evolution of sort of converting people from savers to investors is really going to continue to drive the growth of passive, because at the end of the day, these are really simple vehicles. They are easy to understand, and they are really suitable for the masses.

Wall: Joe, thank you very much.

Parkin: Thank you.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

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Emma Wall  is former Senior International Editor for Morningstar