With an ever-growing focus on charges, low cost managed portfolio services (MPS) using exchange traded funds (ETFs) to reduce fees are becoming ever more popular.
The premise is simple and means many propositions come in at under 1% at a time when the total expense ratios (TER) on many truly active discretionary portfolios top 2%.
But what are investors sacrificing to achieve the lower fees and how constrained are the managers in terms of what investments they can access?
To many it will depend where you stand on the interminable active versus passive debate.
But for Graham Harrison, group managing director of Asset Risk Consultants (ARC), low cost passive MPS are a broadly sub-optimal approach if they eschew actively managed third-party funds as a default.
‘Several MPS have active asset allocation with passive exposure. The manager is saying you pay me 0.3-0.5% for the active management and if you have a TER limit of 0.7%, that’s effectively why you end up in ETFs,’ he said.
‘I think that’s more the manager looking to achieve a particular TER than saying this is the best thing I can do for you. You’d get better if you went direct and got what I’d call an active/active portfolio.’
Of course providers will argue differently, saying asset allocation is the key driver of returns and the compounding of high charges over time erodes gains. Performance comparisons can
also be difficult, with many passive MPS having been launched over the past year, therefore lacking sufficient track records to allow for meaningful analysis.
Stock selection straitjacket?
And for many, while keeping an eye on costs is key, the sheer breadth of ETFs available means the constraints on what asset classes or investment styles can be accessed is overstated.
‘For our passive funds of funds of course cost is a major consideration that clients consider when looking at these products, but to my mind, “low cost” shouldn’t be conflated with “lowest cost”,’ said Tilney Group chief investment strategist Ben Seager-Scott (pictured).
‘Keeping a focus on cost is important in all parts of investing, because cost is one of the few drags on performance that you can specify in advance, so it is an important consideration for after-fees returns. But starting with a cost “budget” can be risky.’
Peter Sleep, senior investment manager at Seven Investment Management (7IM), said his firm’s MPS has evolved over time, freeing him up to be able to invest in a wider range of ETFs.
‘We started out our MPS about five years ago as a very low cost passive offering. Over time we have enhanced our offering by adding things like hedged ETFs and market neutral funds as they became more readily available,’ he said.
‘These funds are relatively expensive and I was concerned that adding market neutral funds would push up the overall cost of our MPS offering.
‘The feedback I received though was that I should not worry too much about the cost if the new funds achieved their investment purpose. The most important aspects of the MPS was our service and track record, and not being as low cost as possible. On the other hand, if I let costs rip I am pretty sure management would let me know, so I have to strike a balance.’
While 7IM’s mandate of holding passives would preclude him from holding a traditional ‘two and 20’ hedge fund, alternatives are still a key component of the MPS, which have a 10% weighting to them. He cites the VT iFunds Absolute Orange ETF, a market neutral trend following fund, as a case in point. It has a TER of around 0.8%, which Sleep admits ‘caused him to blink’, but he said the long-term track record ‘justifies its place’ in the portfolios,
‘The smart beta funds and hedged ETFs are probably a bigger contributor to the overall cost of the MPS, but here we are looking to achieve a specific end goal using the cost ratio as a variable,’ he added.
The ETF price war
The ETF price war has no doubt helped free up cost budgets with State Street cutting the fees on its three Russell index ETFs to just 0.03% earlier this month, as an example.
Indeed, often it can come down to haggling over very small amounts, compared to the additional potential return profile of the position, Seager-Scott points out.
‘For a lot of these things, we’re talking a few basis points, so often you’re actually asking what the ‘extra’ return potential is, and here the conversation mirrors that about the value of active management outperformance potential,’ he said.
Some wealth managers do feel more constrained, however, with B Capital founder Lorne Baring saying that factor ETFs, for example, have only just been coming onto his radar. For him, they had been ‘uninvestable’ when charged around 1%, which he said eroded much of their outperformance.
He also stressed that TER in itself is only one of the 25 filters he puts potential ETF holdings through and investors need to be mindful of other indirect costs, such as bid/offer spreads and tax treatment.
‘For example, when choosing between Irish and US ETFs, you might get better tax treatment on the dividends on the Irish ETF, but maybe it has higher charges or is illiquid, so you’d be better off taking the tax hit,’ he added. ●
What do passive model portfolios charge?
AJ Bell MPS: 0.25% + VAT
Brewin Dolphin’s MPS Passive Plus: 0.2% + VAT
Brooks Macdonald MPS (Passive): 0.5%
Brown Shipley Passive MPS: 0.26%
7IM Model Portfolios: 0.2% + VAT
(All fees excluding the cost of underlying holdings)