ETF

I know it makes me sound like an old duffer but I am sure fashions come and go quicker these days.

The latest must have investment accessory is the Inverted Index Fund.  These return the opposite of the index and allow investors a way of shorting.  There are not many ways for private investors to take advantage of a belief than an index (or other investment) will go down in value, other than not investing in it, so some will welcome there arrival.  A number of fund groups are scheduling launches, almost certainly in equities and commodities so watch this space.

Whether there is a place for these in the portfolio of a long term investor, I am not so sure, but they are certainly of interest.  Technically, many things are becoming possible and I am sure we have only just seen the start of much innovation but as investors we shall need to be careful not to be sucked into the hype.

If, however, you have been waiting for a simple tool to allow you to make money (we hope) from shorting, it may be that your waiting days will end soon.

In these uncertain times, it is hardly surprising that some investors are turning their attention to Gold, the traditional refuge.  Gold has outperformed most major stock markets this year (up about 20%) as well as many other indices, although Sterling returns are hampered by the fact the Gold, like most commodities, is quoted in US Dollars.

For most investors, though, Gold presents a few practical problems.  Firstly, it is expensive and I doubt many bullion merchants would be happy to sell a small piece of an ingot.  Secondly, it is costly to store and insure; it is hardly much of a refuge for your money if it lying about the house.  Also, most investors would not know where to go to buy it.  On the plus side, allocated bullion represents no credit risk and it does represent a traditional preserver of real value, even if its track record in this is patchy.

Access to gold has recently become easier; a number of ETFs (Exchange Traded Funds) now exist, some of which give access to allocated gold bullion.  This means that investors can include Gold in their portfolios, whether it is a good idea or not is another matter.  

It is quite likely that soon every conceivable investment niche will have been covered as Barclays has just launched an ETF tracking Timber and Forestry.  This fund will track the S&P Global Timber and Forestry Index and will come as a welcome relief by all those stressed by their lack of ability to do so.  Most, however, will not find their world rocked by this arrival but it does illustrate a trend, that of Alternative investments.

Alternatives, which include Hedge Funds and Private Equity as well as art and forestry, amongst others, have become much talked about in the last five years, or so.  Popularised by their successful inclusion in the influential Harvard Endowment Fund, they have spread out into many Wealth Management portfolios.  Their supposed benefit is high returns uncorrelated with equities.  There are one or two problems, though.  Firstly, as with all diversification, if everyone does it, the benefits of the diversification are reduced.  Secondly, any prospect for excess returns disappears when everyone piles in, certainly if you are not the first.  Harvard benefited enormously by getting in early and waiting for their imitators to pile in and drive up values.  Thirdly, what works for a multi-billion dollar fund with an indefinite timescale, may not work for those of us with fewer resources at our disposal.  Harvard went out and bought forests, not funds tracking the fortunes of forestry companies.  It is unlikely that forestry shares will exhibit the same characteristics in terms of returns and volatility as actual forests.

However, do not underestimate the power of marketing and investors desire to buy into a bandwagon after it has left town.  That is not to say that their may not be a place for it, it is just wise to manage your expectations.  For those with deeper pockets, their are funds which give access to forestry ownership, albeit with higher costs than Barclays iShare levies; currently a modest 0.65% per annum.

Investing in commodities, by which, it is normally meant the raw materials for industry such as minerals mined, metals refined or agricultural produce, presents a number of practical obstacles.  Private investors can hardly take delivery of several tons of wheat, for example.  

Traditionally, institutions have made money from the commodities markets by trading in forward contracts, futures and options.  These markets are notoriously difficult territory for smaller investors and not generally appropriate for a long term strategy of buy and hold.

So why the interest in commodities?  Well, they can provide the opportunity of an uncorrelated return to add to an investment portfolio, i.e., they do not go up and down at the same time as equity markets much of the time.  Diversification is central to portfolio construction and the search is always on for assets which increase this.  However, as everyone rushes to diversify, assets can start to become correlated.  That said, there is still a case for the inclusion of commodities, even though they have no income generating prospects, important to many investors.

Most will obtain some interest in the commodity markets by investing in companies which derive their earnings from producing them, mining stocks, etc.  Now, however, there are increasing numbers of Exchange Traded Funds (marketed as Exchange Traded Commodities, ETCs) linked to commodities indices.  These give the opportunity to access returns on a broad range of commodities from platinum to oil to livestock and are worthy of consideration for inclusion in a well diversified portfolio for the long haul.

The rise of ETFs seems to be inexorable and this year, though fraught with difficulties for investors, may see record inflows.  Although they are much used and appreciated by many institutional investors and the more sophisticated financial advisory firms, they are yet to make significant inroads into the retail market.

There are a number of reasons for this:

Firstly, not everyone is sure what an ETF, or Exchange Traded Fund is.  Most investors are familiar with collective investments, such as Unit Trusts and OEICs (Mutual Funs in the US), which are pretty much the same thing, and Investment Companies, as Investment Trusts are now labelled.  These pool investors cash to buy a portfolio of investments sharing out the returns and losses.  Unit Trusts can be purchased directly from the managers or through the many platforms and fund supermarkets now available and most are priced once a day to reflect changes in value.  Investment Companies, on the other hand, are listed on the Stock Exchange and bought through a Stock Broker.  Their price may fluctuate during the day to reflect market sentiment, i.e., they are priced in 'real time'.  ETFs are very much the same as Investment Companies with a couple of differences.  Most, if not all, are not actively managed and simply track an index.  They also have no gearing and do not trade at a significant discount or premium to the value of the underlying assets, i.e., they aim to reflect the true value of the relevant index at any given time, and they are priced in real time. They often have lower annual charges than the equivalent Unit Trust Tracker Fund and most launches of Trackers these days are in the form of ETFs.

The second reason why they are less familiar to retail investors is that many of the popular fund supermarkets do not promote them.  ETFs are not designed to offer the fat commissions that Collectives have inbuilt.  This nice commission enables many of the well known supermarkets to offer 'free' switching and attractive 'discounts' to customers.  They can also bundle extras like a 'free' SIPP (Self Invested Personal Pension).  These platforms are often marketed heavily, indeed, they provide the back bone of comment and analysis in the Sunday Papers, and it is hardly in their interests to encourage too much transparency.

However, the word is out and something like $14bn of investors money will find its way into these funds globally this year.  Expect to hear even more about them in the future.