| Trackers: management fees put the brakes on their use |
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| 12/11/2006 | |
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At a time when core-satellite strategies are being more widely deployed by institutional investors, trackers should be considered a natural compliment: they provide a passive correlation to market risk and adjust the more volatile segment of a portfolio, referred to as satellite. Trackers, or ETFs, suffer from an image problem, despite their increasing use by institutional investors who can trade no less than 250 of these index funds in Europe, representing an investment pool of €60 billion compared to €45 billion in 2005. According to a recent Edhec study covering European institutional investors, those dedicated to exchange traded funds displayed a strong interest in the category. Of those surveyed, 55% expect to increase their investments in ETFs in coming years, while futures and synthetic products garnered only 34%, index funds 29% and swaps 28%. This is not to stir up, suggest or encourage an infatuation with ETFs! But these exchange traded funds do seem to be making their way into the portfolios of a number of professional asset managers, such as pension funds, insurance companies and reserve institutions. The many pleasures of being passive What is increasingly appealing about a core-satellite approach is that it can generate performance in excess of a portfolio's benchmark, while at the same time improving its risk level by reducing portfolio volatility. The Edhec study notes that no less than 48% of European institutional asset managers have already adopted a core-satellite approach. So it's no surprise that the adoption of an equity benchmark is central to the decision-making of a portfolio manager; a majority of whom use the Euro Stoxx 50. What they ask for are competitive fees and liquidity and they certainly do not want to take on excessive risk as they fill in their beta market allocation. According to Frédéric Lagier, formerly head of finance at Cancava, who founded Indep 'AM, (Mutuelle Nationale de Retraite Artisans holds a majority stake in Indep 'AM), trackers offer intraday liquidity to better re-allocate a portfolio. This is due to the fact that trackers are listed, whereas non-listed funds can only be adjusted once a day – as opposed to intraday. "These products can be used to adjust a tactical allocation in the passive segment of a portfolio, while allowing entry into other markets like emerging markets, commodities, or sector specific, without disturbing actively managed assets, or adding to specific risks linked to alpha." For an institutional investor, a central question remains performance, or put in another way, the value added by active management. The report card of the last seven years inside the MNRA is that few asset managers have been able to outperform the market. Certainly, trackers are not a cure-all because of their fees and the challenges imposed during the life of a portfolio, but passive management gets high marks for reconciling performance with a higher level of security than other investment approaches. Historically, passive management has improved the results of active management, more than the other way around. Let's look at some numbers. From January 2005 to March 2006, active portfolio managers largely outperformed their benchmarks, but by the end of August, they had lost twice their accumulated gains. For Lagier, this lacklustre performance raises--in a rather blunt way--the pertinence of alpha. Perhaps it is the seduction of alpha that leads an investor to neglect the search for beta. "Looking at the comparative returns of the market and of alpha managed assets, an investor is looking--before anything else--for beta; it's only by necessity that he looks for an active portfolio manager." For an institutional investor, managing alpha is an unpredictable and random pursuit. If certain managers beat the market, nothing assures that they can do it in a durable way. Should this type of active management then be delegated or outsourced? That would only add another layer of risk—that of the portfolio manager—on top of the market. Those managers who place the bets in search of alpha also set the limits of their investment parameters and convey to their providers the risks inherent in pursuing such a strategy, risks which they try to reduce, though their specialised services command higher fees. Given these conditions, institutions can commit a bigger portion of their portfolio to passive management, but not necessarily trackers. "With management fees of more than 25 basis points, these products are too expensive for institutional investors," says Lagier. An in-house portfolio with €100 million, however, could pay a fee as low as 10 basis points. "With a bigger portfolio, the fees do not have to be higher than a few basis points." Tracking tracker fees What are the fees charged for trackers and how do they compare to those of a Vanguard mutual fund index? Lyxor Finance, based in France, offers a wide selection of trackers. In emerging markets, the Turkey Titans 20 charges a .60% basis point fee on an annual basis. This tracker is heavily weighted in the financial sector. The Lyxor ETF Nasdaq 100 tracker takes a .30% fee and the MSCI USA, which was introduced last March and closely correlates the S&P 500, has a .35% fee. On the fixed-income side, the Lyxor ETF Euro MTS 10-15 year, which tracks government bonds in the euro region with 10-15 year maturities, has a .165% annual fee. Meanwhile, Vanguard's Intermediate-Term bond index fund charges a .18% fee. It also charges .18% for its equity fund, the 500 Index Fund. Its Emerging Markets Stock Index rises to a .45% annual fee. In recent months the competitive landscape for trackers has intensified in Europe. Generally, that should augur well for lower prices on most goods and services. One would expect the market for trackers to follow the same economic principle, however, heightened competition can also result in higher marketing fees. Another factor that may put the brakes on lower fees: index providers and builders charge excessive licensing fees. For Laetitia Roche, head of marketing in France at Lyxor Finance, if institutional investors deploy more funds in trackers, it's because these products are more liquid and less costly and because they have a more constant risk profile, which is market risk or beta. With the core part of a portfolio linked to a benchmark, the portfolio manager can actively search for non-index correlated instruments that can outperform the benchmark (for example, Asia could be considered belonging to the satellite component). "Liquidity is always guaranteed with trackers, the investor always has the certitude of finding a counter party to buy or sell the product, what ever the size of the order," says Roche. The success of trackers also reflects the propensity of managers to diversify their holdings over time. Trackers for South Korea and Turkey are attracting strong demand, notes Lyxor. The diversity of trackers often mitigates the absence of futures and synthetic products in certain niche markets. Trackers also offer an efficient way to re-weight a portfolio such as playing a country relative to where it is in the economic cycle. Lyxor has launched 17sector trackers based on the Dow Jones Stoxx 600 index based on geography and style. Certain professionals use them to put into place a sector rotation strategy, that is, they roll out of one sector and move into another. J.A and V.B |
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