Growth in popularity of exchange-traded funds offers risk diversity
RISK diversification is always a vital part of any investment strategy, although it is often easier to pay lip service to diversity than to do anything concrete to spread your risk.
One increasingly popular method of risk diversification is exchange-traded funds or ETFs which were developed by the US financial services giant State Street in the 1990s and which have since become a significant investment tool for both small and institutional investors.
ETFs account for about a third of all US stock trading volume and global ETF assets under management total $933bn (€645bn). Indeed they are so popular in the US that the 'Dummies' series of books includes a useful volume entitled 'Exchange-Traded Funds For Dummies' by Russell Wild.
ETFs differ from the better-known mutual funds because they are listed on stock exchanges just like shares and can be freely traded. They also cost less to manage, with the average mutual fund costs about 1.67pc in annual operating expenses while the average ETF costs about 0.3pc a year. Any canny investor knows that this adds up over time and can lead to a significant divergence in returns. While this is a significant advantage, it is worth remembering that trading fees are expensive so mutual funds can be better for investors who like to regularly chop and change their investments.
Despite ETF's success on the other side of the Atlantic, ETFs still have someway to go in Europe where there are not the same tax incentives as in the US. State Street has this week issued an interesting and useful report on ETFs (www.statestreet.com/vision/) which argues that regulation has historically stifled rapid ETF adoption in Europe as the non-harmonised nature of European markets has meant that achieving scale in funds was difficult. This has been changing over the past decade, and sales and marketing activities have picked up across borders. Notwithstanding this, State Street estimates that only 10pc of US-listed ETF assets are from European investors.
The report notes there are serious challenges to introducing ETFs into mainstream retail distribution in Europe (unlike in the US where some brokers are selling ETFs alongside mutual funds). This has meant that ETFs have an overall lower penetration in European client portfolios than in the US. State Street predicts that once these barriers come down, the European ETF market should grow above average global rates.
Funnily enough, while ETFs still have to find favour in Europe, many ETFs are listed and traded in Dublin where the Irish Stock Exchange is busy building up a healthy business in listing funds of all kinds. Buying them here or overseas is relatively easy and anybody wishing to buy ETFs can simply contact discount brokerage houses online or contact a stockbroker who can buy them on their behalf.