HL fee cap on ETF's?

bowlhead99

mcooke999 said:

Great thanks everyone.

This might sound like a stupid question but I'm just wanting to check, are there any reasons why ETF's are any more risky than funds (when comparing like for like in terms of the index they track or whatever)?

To borrow a bit from my own post on Happypie's Sipp thread this morning, which you've probably seen:

A new investor may find ETFs more complex than 'funds' as they have a real-time price on the stock market rather than simply one daily agreed price; and some providers' ETFs can have more complex features such as gearing; and ETF shares don't qualify for any FSCS coverage - though you might take the view that FSCS coverage is not likely to ever get used because it won't cover general investment losses, only unusual situations like fraud.

You also find that some ETFs may use more 'synthetic' financial instruments than would be used by traditional OEICs or other ETFs, giving you extra 'counterparty risk' where they don't actually hold all the underlying securities that they are trying to model and track in their portfolio, giving more potential for things to go wrong in extreme market conditions. 

However these days for the major indexes there are plenty of mainstream providers using full direct replication (or at least sampled/optimised replication) of the index they intend to track, by holding real shares of bonds of the companies they're trying to track, rather than hoping to cheaply generate the same return as the index with a large value of 'total return swaps' or the like. 

ETFs generally give good and timely details on their holdings (a key requirement as they're traded on the open market) which means you can generally see what they are up to. It's common for their regularly-published info to include information about the returns they make on stock lending - a practice that increases the risk of failure, though hopefully not too much, in order to make a bit of income on the side that has the effect of shaving a little bit off the fees without actually doing so.

Regulated funds that are not ETFs can still have some quirks and use financial derivatives to make themselves more efficient, but you generally associate the more esoteric investment techniques with ETFs - as there are fewer restrictions on what you can do, if you're just creating a packaged investment product to be tradeable on a stock exchange by any Tom Dickenharry; rather than working in the confines of the open ended fund regulations to provide something accessible only through the distribution channel of a fund platform intermediary.

If you go into ETF ownership with your eyes open and know how they work, do all your research and stick to 'basic' ones for mainstream indexes from major providers, they are not something to be scared of - just another type of fund product. However if you don't fully understand how they work from end to end, you may prefer to stick to traditional funds, which most regard as simpler. 

If you are asking what to look out for, you probably have not done all the research you need to, because you won't necessarily get lucky enough to have someone in a forum tell you what you need to look out for, because they don't know what you know or don't know or what particular ETF you're going to buy. Start with reading the prospectus from front to back and when you think you know what it all means, come back here to double check.

Albermarle

However if you don't fully understand how they work from end to end, you may prefer to stick to traditional funds, which most regard as simpler. 

After reading more about ETF's and 'creation units ' and 'authorised participants' I decided to follow the theory of 'don't invest in something you do not fully understand ' 

I am sure they are fine and it was just a personal choice . As you say funds, (and Investment trusts) are easier to understand.

bowlhead99

Albermarle said:

However if you don't fully understand how they work from end to end, you may prefer to stick to traditional funds, which most regard as simpler. 

After reading more about ETF's and 'creation units ' and 'authorised participants' I decided to follow the theory of 'don't invest in something you do not fully understand ' 

I am sure they are fine and it was just a personal choice . As you say funds, (and Investment trusts) are easier to understand.

When I was writing the above I had in my mind the comments on another thread from one of the anti-IFA posters who believes the industry is out to portray investing as more complex or nuanced than it really is, in order to scare people into paying for advice or buying more expensive products that help their fatcat mates in the city to cream off management fees or other layers of charges.

That poster would probably say about ETFs:  it's not complicated because it just tracks an index, the fees are low, your broker will often let you buy it without an ongoing platform fee, and if you change your mind you can just sell it on the stock exchange - what's not to like?!

But I do think it is more complicated than that.

E.g., you pick a European tracker ETF because it has a decent performance chart and low expense ratio and you can buy it through your cheap execution only stockbroker for a fiver as it's listed on the London stock exchange and settled through CREST.

When you buy it, you notice there is an annoying bid-offer spread because it's only a €40m fund size and tightly held so market liquidity of relatively low. You hadn't expected that, but you've bought it now. Never mind.

Six months later the main institutional investor for whom the ETF had really been created pulls out and wants their €30m back, so they reduce the fund size and now the ongoing charge figure is a higher percentage than it once was. Never mind, you'll give it some thought later and maybe sell it. You defer the decision for a while.

To save cost and due to lack of demand from UK investors they cancel the London stock exchange listing - but you don't notice because you don't read regulatory news service releases and the automated email from your broker lands in a spam folder. It's still listed in Italy and Switzerland but your broker doesn't trade on those exchanges. Ah well never mind, will do something about it later, don't need to sell it right now.

Then in some market turmoil they get screwed over by a counterparty to some of their stock lending activity, the AAA bonds they took as collateral lost value when interest rates rose and the bonds are now worth less than the borrowed stocks and the defaulted borrower can't repay. Ah well never mind, an annoying drop in NAV. Wish you'd sold earlier but hopefully a one off issue.

Then a defaulted counterparty to a total return swap loses them more money, and they were using Lehman brothers as a custodian who go into administration so they can't do much with the title to their assets. Fortunately as a tracker they are not actively trading much anyway but liquidity dries up because they can't let institutional traders sell out in exchange for stocks, because everything's a mess.

You lose track of what's going on especially with it being a product that's not listed on a UK stock exchange any more - but long story short, it liquidates with a bunch of wind-up costs at the bottom of a bad market, and you lose a bunch of money and it's a hassle to get back what you didn't lose.

The FSCS and your original broker are no help because it was an execution-only non-advised trade, buying shares in a foreign domiciled (Ireland or Luxembourg) entity.

You think to yourself - if only you'd read the prospectus that made it clear what some of the risks were... 

Or for those reading the risks but lacking practical experience of the investment sector: if only you'd both read the risks and had the imagination to figure out what some of the consequential issues of some of the risks might be.