An article published recently on FT.com detailed the rise in use of ETFs as an alternative to actively managed (or passively managed) Mutual Funds. The piece, ETFs are Eating the Stock Market, notes that the reasons investors choose ETFs over Mutual Funds are well understood, and can be summarized as broad investment allocation across segments with low fees. The article goes on to surmise that ETFs are here to stay, even with a presumed turnaround in active management in 2017. So for those firms selecting ETFs as a quick and easy way to gain exposure to a specific segment, what might be the overall impact on your portfolio, and how can you prepare for the potential of hidden (and unintended) risks?
How Can Firms Achieve and Deliver Transparency into ETF Investment Results?
As the investments in ETFs continue to grow, Portfolio Managers and their customers will continue to demand more transparent reporting of those investments. Transparency, after all, is key to assessing risk factors in a portfolio. Performance and Risk analysts have long dealt with the challenges presented by ETFs, and for that matter other securitized investments. In fact, BISAM often hears that robust reporting capabilities for ETFs is a key decision criteria – the so called X-Ray (or look through) reporting that translates an investment in a fund into an investment of the securities within that fund. But with this comes challenges that firms should consider:
- Look through functionality is only as intelligent as the data provided. Ensure there is a source for detailed ETF data that is consistently updated and provides the security characteristics to match the investment strategy of your portfolio. Integration with a provider is key to understanding the role ETFs play in the overall allocation of your portfolio.
- ETF data provided by an outside party is never a complete replacement for the investment in the ETF – performance results will almost always differ. The presence of transactions, differences in pricing sources and differences in FX rates can all lead to a residual in the invested return vs. the look through return. Understanding where the return deviates, and why, increases trust in the results.
- Delays are inevitable in the production and availability of ETF data from external providers. Using historical (or stale) data as a backfill to provide analysis on a go-forward basis is common, but ensure you can restate once official results are available.
In future posts - via the BISAM Insights blog - we’ll delve more into ETFs and share additional thoughts for overcoming obstacles in measuring ETF investment performance and risk management. If you have specific comments, questions or issues you’d like us to address on this topic, please submit via the comments box below or send an email to our editor: [email protected].
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