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ETFs still a risky bet, says selector

ETFs still a risky bet, says selector

Thematic approaches and low fees continue to reel investors into passive investments, but will this advantage disappear as ETFs get more complicated? One investment professional gives his take the rise of passives.

Selector: Damien Armand

Company: Financière de l’Arc

Passives have become increasingly important in portfolio management, especially active management. Managers seek to deliver performance by adjusting their smart beta which mainly corresponds to risk-focused beta and return-focused beta.

Even if our portfolio management is concentrated on pure alpha and traditionally active, we are still using some passives and are looking for opportunities, above all, in asset classes we do not know.

Passive funds are also attractive because of their low fees, systematic implementation and high capacity. But let’s not forget, they still have a market risk.

Research is key

In 2016, only 28% of active funds outperformed their benchmark. Over the last 10 years, 19% did. In many cases, passive management would have been the more appropriate solution. In fact, smart beta indices outperformed 98% of the active managers in developed markets.

However, when assessing whether a market is efficient or not, managers need to study sub-asset classes to fully understand the sector.

In markets such as high yield, for example, they would need to factor in whether the market included the energy industry. In the US, the environment seems to be favourable for passives and strong correlations, and the same is also the case for ETFs in selected emerging markets.

Keeping a close watch

In a post-Lehman Brothers world, asset managers and clients are looking for clear, easy and transparent solutions.

Traditional asset managers are developing new offerings around ETF products and therefore spend a lot of time clarifying the investment process for clients and doing due diligence. Passives are becoming more common in the asset management industry and insurers are starting to sell them to their clients.

If used correctly, ETFs can be a safe and effective way to hedge against tail risks. Despite them becoming more popular, the need for close scrutiny by compliance teams is as important as ever.

These comments originally appeared in the July/August edition of the Citywire Selector magazine.

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