Our Insights

About personal finance, investments and markets.
April 6, 2017

The role of ETF in our investment process

Many investment advisors still avoid index funds (ETF) for long-term investing. However, advisors who keep pushing the same old products as in the past, despite their obvious short-comings, are becoming part of the problem rather than helping clients find the optimal solution. ETF are no silver bullets, but they offer distinct advantages over traditional mutual funds that help serious savers get the job done better:

  • Lower costs: While actively managed mutual funds typically charge upwards of 1,5% annual management fee (plus initial sales charge and plus a performance fee in some cases) an ETF can be bought for as little as 0.1% p.a. The fees investors pay to mutual funds account for a third and sometimes up to a half of their potential gains over the years.
  • Better performance. Empirical studies have shown that actively managed mutual funds have a very small probability of outperforming an index over a longer time frame. For a typical large cap US equity fund, the chances of outperforming over the last 10 years were only 1%. For bond funds, the picture isn’t much better. With odds so poor, why would you buy mutual funds?
  • Superior transparency. While mutual funds typically only disclose their top 10 holdings, ETF mirror an index that is 100% known. There are no surprises.

The empirical evidence in favour of ETF is so compelling that I rely on ETF for my own long-term investments and those of my family. I worked 15 years in London and Hong Kong at a global investment bank and could see first hand how the mutual fund industry is largely failing their clients. We are therefore using ETF as the core building blocks in the investment strategies of our clients. Our job is to help our clients reach their goals – and ETF are the best products to do so.

In Germany, the investment product landscape looks very different: ‚advisors‘ (or should we rather say ‚sales-people‘ because they get paid commissions?) are recommending mainly actively managed balanced funds. In our view, they are failing their clients because most of these balanced funds massively underperform their benchmark (see here)! Worse, the core role of an advisor should be to translate the financial goals of a client into the right asset allocation. Empirical studies show time and again that the proper asset allocation is what drives about 80% of the long-term performance. By selling balanced mutual funds, the traditional advisor hands over the responsibility of deciding the right asset allocation and ultimately shows that he adds very little value in the investment process.

Summary

If you are a do-it-yourself investor or if you use a wealth-advisor, you should make sure that ETF form the core building blocks of your investments. ETF are not perfect, but assuming you can control your behavior, indexing gives investors the best chance of capturing whatever returns the market will deliver.