Why is that most ETFs are passive and ITs are active?

Mr.Saver

Correct me if I'm wrong. The vast majority of ETFs are passive index funds, yet all Investment Trusts in the UK are active.

Of course, not all indexes are created equal. Some indexes are actually more active than some active funds, but that's not the topic of this discussion.

I can't seem to find anything preventing or discouraging the creation and operation of a passive indexing IT. Why isn't there any such IT available? What's causing this phenomenon?

wmb194

Mr.Saver said:

Correct me if I'm wrong. The vast majority of ETFs are passive index funds, yet all Investment Trusts in the UK are active.

Of course, not all indexes are created equal. Some indexes are actually more active than some active funds, but that's not the topic of this discussion.

I can't seem to find anything preventing or discouraging the creation and operation of a passive indexing IT. Why isn't there any such IT available? What's causing this phenomenon?

There used to be at least one, launched in 1990, called Aberdeen UK Tracker Trust, LSE:AUKT. It was fully replicated i.e. held shares in every company and tracked the FTSE All-Share. My notes say it delisted on 18/04/17.

I'm having a hard time finding its RNSs but IIRC the RNS which announced that it was going quit this strategy and merge with BlackRock Income Strategies Trust to create abrn Diversified Income & Growth Trust, LSE:ADIG, gave reasons along the lines of lack of scale, costs and the inability to compete with foreign domiciled ETFs on the 0.5% stamp duty issue which made it less attractive to investors and concomitantly contributed to its lack of scale. I also vaguely remember that it traded at a 5%+ discount and had a wide bid/offer spread, something that most ETF trackers or at least the big ones don't suffer so badly from.

Essentially, in investors' eyes ITs need to add some sort of value beyond simple tracking.

masonic

Mr.Saver said:

I can't seem to find anything preventing or discouraging the creation and operation of a passive indexing IT. Why isn't there any such IT available? What's causing this phenomenon?

I suspect it comes down to the IT corporate vehicle being less efficient if you are effectively outsourcing your stock-picking to an externally provided index. For example ITs are public companies whose board of directors must be elected by shareholders, which must publish annual reports, and which must engage an independent investment management business to manage the investment portfolio and regularly report to the board and shareholders. That all seems a bit superfluous if you are just planning to follow an index.

wmb194

masonic said:

Mr.Saver said:

I can't seem to find anything preventing or discouraging the creation and operation of a passive indexing IT. Why isn't there any such IT available? What's causing this phenomenon?

I suspect it comes down to the IT corporate vehicle being less efficient if you are effectively outsourcing your stock-picking to an externally provided index. For example ITs are public companies whose board of directors must be elected by shareholders, which must publish annual reports, and which must engage an independent investment management business to manage the investment portfolio and regularly report to the board and shareholders. That all seems a bit superfluous if you are just planning to follow an index.

Plus in person AGM/EGMs as well. Apart from possibly its last one when something interesting was happening, I wonder how many shareholders ever bothered to turn up to AUKT's?

Mr.Saver

wmb194 said:

Essentially, in investors' eyes ITs need to add some sort of value beyond simple tracking.

Gearing could be the added value. IT can borrow 20-30% in cash and invest in (physically hold) the underlying stocks and shares. ETFs can't borrow cash, they can only use financial instruments, such as swap, to produce a leverage, but this is not a suitable solution for long term buy and hold investors. Most leveraged ETFs reset daily, very few resets weekly or monthly. The frequent reset means they will "leak" value if it was held for longer period of time. Also, they are not ISA or SIPP eligible. 

Outside ISA & SIPP, a margin loan or long dated call option can be used if the investor wants to have more than 100% exposure to the market. The need for leveraged funds product exists in the tax wrappers where margin and option trading are not available. The only way to leverage up inside an ISA is to buy an investment product with an internal leverage, like an IT.

I think theoretically it's possible to create and run a leveraged IT which remain at a certain range of gearing at all time, and only "reset" when the market have moved in one direction far enough (i.e. when the gearing exceeds a certain amount on either direction). This should make it suitable for buy and hold investors in an ISA or SIPP wrapper seeking to have more than 100% market exposure.

EthicsGradient

Until other trackers cut their costs aggressively, AUKT managed to outperform the All Share Index, and thus probably other All Share trackers, since it could use the discount to buy back shares when cheap: https://citywire.com/investment-trust-insider/news/unusual-all-share-tracker-trust-cuts-charges/a830275 . But if the OCF was more than competitors', investors would avoid it, rather than taking a chance that this could happen again.

Mr.Saver

masonic said:

I suspect it comes down to the IT corporate vehicle being less efficient if you are effectively outsourcing your stock-picking to an externally provided index. For example ITs are public companies whose board of directors must be elected by shareholders, which must publish annual reports, and which must engage an independent investment management business to manage the investment portfolio and regularly report to the board and shareholders. That all seems a bit superfluous if you are just planning to follow an index.

I believe ETF also need to produce annual reports. But, yeah, they don't need to elect the board of directors or have AGMs. That's certainly an advantage.

Tolteca87

Many IT's also predate the instruments used to replicate indexes to create ETFs. Some even predate some indexes such as those going back to the Victorian era.

Personally I like the flexibility gearing offers to ITs so they don't become forced sellers in crashes - i.e. the worst time possible - and the ability to pay dividends from reserves so they keep paying me in short term bad times. I also like picking up some nice dividend income at attractive discounts in crashes.