Sound Financial Group Blog

Cost is a vital consideration within fund management and you need to ask yourself how much are you paying in investment charges within your Pensions, ISAs, etc…but it’s not just cost that’s important...

Cheap isn’t always cheerful. In the world of investing, you get what you don’t pay for is a saying that we adhere to at Sound. Fund management costs can drag the performance of the so called best funds (those with the best ‘star’ ratings for example that top the charts one minute and fall like a stone the next) and so for many years now we have advocated investment at low cost to prevent such ‘cost drag’ form damaging long-term investment gains.

The use of Exchange Traded Funds (ETFs) has been growing in popularity over the past decade and can give exposure to many assets classes at very low cost, as low as 0.25% pa in some cases. Of course the costs to hold these assets on an investment platform and within a certain type of investment ‘wrapper’, such as a pension, ISA or investment bond, needs to be taken into account.

Investors need to know the type of ETF they can hold and the associated risks. In essence ETFs can physically own the underlying securities, for example UK shares in the case of a UK Equity tracking ETF. Alternatively they can be what are known as ‘synthetic’ ETFs whereby they do not hold the underlying assets. A good example of this are commodity futures ETFs whereby it would be impossible to hold large amounts of say wheat, corn, cotton, coffee, sugar, oil, or whatever. So in these ETFs the investment provider promises to give the investor a return equivalent to the commodity index that it is tracking. All simple so far.

However, investors need to be aware of where their money is actually invested as it could be that the collateral put up by the investment firms counterparty, normally a large bank, could be something entirely different. Some ETFs and ETPs (Exchange Traded Products) will buy and sell complex derivatives or ‘swaps’ which played a part in the global credit crisis of 2008. These are known as ‘synthetic’ ETFs/ETPs. They may also borrow to invest and such gearing can add to returns, but also increase massively the risk if the fund were to get into difficulty.

The FSA has started to look closely at such products and are rightly attempting to educate investors as to the different types of risks involved. Furthermore, as the counterparty to many of these funds are large banks, some with exposure to the debt building up in Greece and the Eurozone, there is further concern that this ‘counterparty risk’ could repeat what happened in 2008 and leave some funds illiquid and/or worthless.

The simple message is if you don’t understand what is going on within the investment and how the returns are derived, don’t take the risk.

If you wish to discuss your own investment planning strategy or would just like a second opinion on your current investment arrangements, please contact us and take advantage of a no cost or obligation meeting.