Pensions World

Despite the impressive success of exchange traded funds, UK pension schemes are reluctant to use them. Anthony Hilton, Evening Standard, explains

Some six years ago the chief executive of one of our leading fund management companies told me he was thinking of leaving the business because, looking into the future, he could not see why anyone would buy his funds. It made so much more sense he said to invest through exchange traded funds. And he was as good as his word – he left about six months later.

ETFs, as they are always known, are securities which are bought and sold on the stock exchange just like normal shares but their purpose is to replicate an index – at its simplest the FT 100, but in fact, as the number of products has proliferated, almost any index or asset class to be found anywhere in the world. The traditional ETF is actually backed by a basket of the shares in the index and as money flows in and new ETFs are created more shares are bought, and the reverse happens in times of outflows. In more difficult markets where such exposures are harder to achieve, some of the more sophisticated products achieve their index replication through swaps. As a result, these days an investor seeking to buy gold can do so by buying an ETF – either one investing in gold bullion, in gold shares or in gold futures. Similarly investors can buy exposure to the leading indices in Brazil, India, the Middle East – any emerging market, and either large medium or small cap.

Great success story

Clearly they meet a need for they have become one of the great success stories of the past decade. In just ten years, according to a recent report on fund management produced by Credit Suisse, they have enjoyed a compound annual growth rate in Europe of 80%. The funds invested have grown from nothing to $218bn.

But as Alan Miller, a partner and fund manager with SCM Private, told a recent Stock Exchange conference, this is still only scratching the surface. Europe is still only 22% of the world market for ETFs he said and those listed on the London Stock Exchange account for just 5% of the global total. In contrast they have become the investment of choice in the US retail market and in a recent period of market turmoil a leading US ETF which gave exposure to Standard & Poor’s was the eighth most actively traded share in the market with 80m changing hands in one day – more than Apple. Thus Mr Miller believes the potential is so huge that, after a career with Gartmore, Jupiter and New Star, he gave up on conventional asset management and his current company only does ETFs.

And in America pension schemes are also beginning to use them. According to a March 2010 study by Greenwich Associates, use of ETFs among US pension schemes, endowments and foundations has grown to about 14% which amounts to roughly half the total of funds invested in the sector. About half of those polled said they used ETFs for tactical purposes – transition, rebalancing, obtaining hard to achieve exposures – a fifth said they used them strategically to implement long term investment decisions, and the balance claimed to do both. They almost all said they expected to do more in future.

Initiative

But in spite of the obvious advantages they bring in terms of low cost, flexibility and ease of diversification, ETFs are seldom used by pension schemes in this country. The failure by ETF providers to engage trustees’ attention is a major frustration. – which is likely to persist unless trustees take the initiative. Consultants make a lot of their money from the hiring and firing of active fund managers. ETFs are designed to give exposure to indices so hiring and firing becomes much less of an issue. To encourage the take up of ETFs is therefore not in the consultants’ business interest.

Anthony Hilton is financial editor, Evening Standard; anthony.hilton@standard.co.uk