This week we had a great question about ETF’s and managed funds. We’re going to be looking at the pros cons and why you’d choose a managed fund or exchange traded fund. We’re also covering the role of robots with our money, robo-advisers and what it entails. Finally, we’ll cover what to look for in a financial advisor.
What is an ETF?
Starting from the top, ETF is short for exchange traded fund. All it is a fund that is traded on a stock or security exchange. You can buy an exchange-traded fund on any exchange.
It’s basically just a basket of shares, for one price.
ETF’s work off indexes, so you can track them. For example, if you bought an ASX200 ETF you’re picking up the 100 biggest company by their market cap. These are always changing, but you’re always in the best 100 companies.
It works on a proportion of how much each company makes up of the index. With exchange-traded funds, it’s all about how much of the whole exchange one company makes up. So to give you an idea in the ASX300 – 25% of the companies in that index are just the big four banks. So when those companies go poorly, like if CBA loses 10% (which makes up about 10% of the index) you’ve lost 10% of 10% which is 1% of performance. Whereas if you’ve only got CBA stocks, you’ll lose the full 10%. So they’re good for diversification.
It’s structured like a direct share but it still has underlying costs. You’ll have an MER which costs a percent, this depends on the asset and the underlying manager. Some range from ½% down to 0.5%. They’re cheap to own and hold, but the thing is, you’re invested in that index and if there’s a fee you’ll always be lagging.
Positives and negatives
Compared to buying shares individually, there’s a positive, because if you’re going to buy 300 shares directly you’ll pay brokerage for every one, and if you don’t have a lot of capital you won’t be able to do that.
A negative is that they lack a bit of control. You can select the industry area you want to be in, like resources or health care, but you can’t select the underlying shares. ETF’s are generally more volatile compared to an active manager when playing in the same space. Standard deviation is about 14 as opposed to an active manager which is between 8 to 12. Index itself can be more volatile, however monthly investments means that volatility can be your friend and you can average out the costs over time.
Actively managed funds
Managed funds are just a structure where you give a managed fund money and they buy and sell on your behalf. Managed funds have mandates, one might be high-income funds or growth-only shares. You can also select the large cap like big shares sectors – top 50 in Australia or small cap like smaller companies. This is where buying active managers in a smaller space can really help.
It all depends on the manager. It’s not the fund itself but you’re buying the underlying manager and the analysts. Those cost you pay for in addition, are about 0.7% to 1% higher than what an index is. If they do their job properly, they can get a better return. There are benchmark aware funds where they track themselves to an index. They’re called benchmark huggers in the industry – it’s better to just buy an index a lot of those time. Those managers tend to have an issue outperforming the index. However if they’re benchmark unaware funds then they won’t touch the big banks if they don’t think they’re a good buy.
I prefer benchmark unaware because they give you true diversification. Also beware that some active managers charge performance fee and this ranges from 10 – 20% of performance.
Why would you do it?
The average manager fails out before the index, 81% of managers were beaten by the index in 2010.
You’re buying that underlying manager. There’s about 30% of quality managers out there and the rest you could say are questionable.
A top player would have to be Paul Taylor from Fidelity, as over a 20 year period has never lost to the index. He’s got a good track record.
Every single managed fund will have an alpha. You can see that if they’re outperforming. Yet a lot of the time they’ll be playing in spaces where your average investor won’t touch. Like China, a lot of the banks make up a massive part of the index and they’re all party run, so there are some dodgy policies. It is recommend that with these sorts of markets you have an active manager on the ground, checking out what’s going on.
ETFs are fairly liquid, but managed funds depend on the underlying asset. It depends on the unit trust and as to how quickly they can liquidate the underlying investment. In the ASX top 50 they’re very liquid. Small cap sector might be 5 days and multi-managed fund up to two weeks. It depends on how quickly they reprice the assets. So that’s about the timeframe it will take.
- Exchange trade funds are good for broad diversification
- Active, generally perform on average.
Robo-advice is delivered by computers or algorithms where you can jump online, put in your income, name date of birth, what you currently have and it will send out advice for you to go and implement.
It’s kind of like figuring out if you’re high or low risk and recommending what you should buy accordingly. They generally advise just on the investment side, so when you get the statement it will tell you the platform and what investment to buy. It doesn’t give you an overall strategic, long-term goal.
For your individual situation, it’s cheap and a good way to get a statement of advice. Generally, it costs just a few hundred dollars instead of personal advice which starts in the thousands. You need a statement of advice every year, however, it won’t update what you should be doing each year.
Sometimes you’ll get a lump sum payment and you won’t know what to do. The statement of advice won’t be able to tell you exactly, which is a downside.
These are good for individuals who are looking to get basic investment advice. Like where you should invest your super or spare cash.
A lot of the time it doesn’t take debt management and that sort of thing into account.
If you have a complex situation or are looking to achieve longer-term goals, you can get tailored advice. Depending on the advisor you go to, they might give you similar advice to robo-advisers. So let’s have a look at what you should ask a financial advisor, and how you can make sure they have your best interests in mind.
What would you ask a financial advisor?
Make sure that they’re asking you the right questions like:
– What’s your goal outcome?
– What are you trying to achieve?
– What are different ways to do that?
This is a good sign.
As opposed to if they don’t ask you questions and just tell you what to do. The advice should be situational and not product or fund related.
Return conversations is a warning sign too – like this fund will outperform for you etc. No one knows if one fund is going to do better than another, and this is a sales tactic. No one can promise or tell you it’ll get a better return because it’s more about the strategies.
- Look at your long-term and short-term goals then break it down over time.
- Do a new statement of advice each year as everything changes
- Products are the last thing to look at.
- Robo-advice isn’t that bad with small balances and for people who can’t afford or don’t require high-level advice.
- Budgeting help could be good but an investment plan may not be necessary
- If you have a more complex situation or want an idea of your long-term means, get some personal advice but remember you get what you pay for. Make sure that your advisor is asking you the right questions. Great promises or products being mentioned in the first meeting isn’t a good sign.
- ETF’s are good for diversification of shares without the research.
- Buy passively on an ongoing basis.
- Managed funds – on average underperform in an index. Look at the volatility measures and 10-year performance track.
- Robo advice – it’s quite basic and doesn’t always take into account your full situation. Investment or super advice is good, but if it’s slightly complex seek personal advice.
- Personal advice – watch out for product pushers who aren’t looking at your situation.
The Rentvesting Podcast, available on iTunes, was created by Red & Co’s Jayden Vecchio and expert financial planner Louis Strange. Together, Jayden and Louis unpack the facts behind the property market, explain what’s really going on & where the market is heading. They believe in challenging the status quo and want to get out there to educate absolutely anyone looking to enter the property market.