Twenty years ago, when I was a very junior journalist at the Financial Times group, I was selected to go to a breakfast briefing hosted by US fund manager Vanguard. At that time senior journalists detested turning up for early morning meetings, hence I got the nomination.
I duly turned up to the offices of a Central London public relations firm for a briefing on what I was told would be a new way to look at fund investing.
Sitting beside me was a mature American gentleman. He introduced himself as John Bogle, the CEO of Vanguard.
John Bogle and ETFs
John Bogle is arguably the pioneer of index fund investing, having introduced the first index-based US mutual fund in the US in 1975. He has to be considered the founding father of the exchange traded funds movement, funds that charge much lower fees to investors, and track the performance of an index as closely as possible. ETFs are now commonplace financial instruments in countries like the US and Japan and are gaining ground elsewhere as well.
Named by Fortune magazine as one of the investment industry’s four giants of the 20th century, Bogle was the first fund manager to point to the huge fees charged by active money managers – for example, in 2004 alone mutual funds charged over $70 billion to their customers, hedge funds another $25 billion.
Investment banks and brokers took another $240 billion.
Bogle was able to prove that passive funds that tracked stock market indexes delivered more of the total return of that index than active funds.
Higher fees and taxes also helped to erode active fund returns.
“The mutual fund industry has been built, in a sense, on witchcraft,” he once said, attracting the ire of many of his colleagues in the asset management industry.
So, why invest in ETFs?
Since I had breakfast with Bogle, the ETF industry has enjoyed rapid expansion around the world.
Apart from their lower fees and ability to outperform active funds, ETFs are listed on stock exchanges and can trade like shares. If you have an account with a broker that allows you to trade stocks, you can also invest in ETFs.
Plenty of choice
The US market offers the largest and most sophisticated array of ETFs: however, other markets like the London Stock Exchange and the Australian Stock Exchange also offer a growing universe of ETFs to choose from. Investors can make use of ETFs to trade a wide range of assets, not just share indexes. Also available are bonds, commodities, currencies, property, infrastructure and thematic ETFs (e.g. with an environmental focus).
Some ETFs allow investors to enjoy a small degree of leverage (i.e. the ETF provider enhances the performance of the fund using derivatives) or behave in an inverse fashion to the index (e.g. making money when a market goes down). For some investors this will make more sense than the much higher levels of leverage used in trading forex or futures with online brokers.
You can invest in ETFs to diversify across markets relatively easily. For those without the time to follow financial markets every day, they can provide a cost effective means of taking advantage of major themes or investment ideas. Think the gold price will go up? Buy a gold ETF.
ETFs are a cheaper alternative
ETFs are also regularly used by day traders and money managers, for example to trade gilts or US Treasuries.
How much cheaper are they than active mutual funds? The Total Expense Ratio of a fund is a commonly used industry measure to express the total cost of owning a fund, not just the management fee, but ALL the fees a fund manager might levy on you as the client.
The average TER for an actively managed equity fund is around 1.91% at the moment – this compares with 0.46% for the average equity ETF.
The difference is considerable.