UK investors are becoming more familiar and comfortable with exchange-traded funds (ETFs) and have mainly adopted them to gain passive exposure so far.
In particular, a report by Invesco found that Britons especially like them to add environmental, sustainability and governance (ESG)-focused investments to their portfolios.
The research shows “widespread adoption” of ETFs as a way of gaining exposure to ESG themes and “open-mindedness” among investors who don’t currently use ETFs, 88% of whom have said they would consider investing in ESG ETFs over the next three years.
But ETFs can be much more versatile than that, according to Ben Slavin, global head of ETFs at BNY Mellon Asset Servicing, who uses them as “hot sauce” on top of portfolios to gain access to the latest ideas that are coming to the market.
“A lot of investors will use ETFs as a passive core and then active or thematic products as satellite holdings to add some measure of alpha,” he said.
“Using thematic ETFs on top is like adding hot sauce on the portfolio, with investors being able to actively trade those sectors or ETFs more frequently and try to add some edge to their portfolio. Even passive ETFs, used this way, are somewhat active because they allow investors to make their own decisions.”
Adding an “edge” is even easier through ETFs because that’s where innovation happens, said Slavin.
“I like to say ETFs is where all the action really is in the industry, in terms of the market really pushing boundaries and being at the forefront of innovation,” he said. “All the new ideas are likely to come and be commercialised inside an ETF wrapper.”
Indeed issuers have been “turning up the volume” on their ETF businesses and new products have been coming “aggressively” to the US, European and UK markets, generating opportunities but also risks.
“It’s not super expensive to launch a product, but it’s competitive. There's been a lot of trial and error in the market, with some solutions having really taken off, and some not.”
Slavin admitted this can constitute a risk for investors, but these new trends are usually given at least three years to get off the ground.
The second-biggest risk for Slavin is not knowing what you hold, as no two ETFs are alike, even if they have the same or very similar names.
“You could have three different products that claim to track solar energy, but there can be a large dispersion of returns because all three portfolios will be accessing the theme differently,” he explained.
“They’ll use different weights, holdings and different constraints. Just because it has ‘solar’ in the name doesn't mean that they're all the same. It's very important from a risk standpoint to really under for investors to really understand what they own and what's contained within their portfolio.”
Investors therefore need to ask themselves if the ETF they’re looking at is correlating to the theme they’re trying to access in the way they want to access it.
But the good news, concluded Slavin, is that, unlike mutual funds and trusts, “ETFs are by definition transparent”, meaning that all their holdings are published on a daily basis.
This gives investors the opportunity “to see exactly what’s being held underneath the hood”, he concluded.