Best Ways To Invest In FTSE 100

May 07, 2014

Last Friday the FTSE 100 topped a 9-week high at 6,838.17 and despite pulling back this week, the rally from mid-February could have pocketed you a pretty penny should you have been invested.

But, short of buying all the stocks yourself, which products are on offer?

While there are several ways to get exposure to the FTSE 100, the first decision to make is whether you want to take an active approach or a passive approach. You then need to make a decision around the investment vehicle – for example, in the passive space there are up to seven ways to get exposure to this index.

Here, we take a look at some of the different products on offer giving exposure to the FTSE 100 and what they could cost you.

ETFs

One good place to start when you are looking at passives is the legal risks.

Ursula Marchioni, head of iShares EMEA equity strategy & ETP research, said: “When you start looking at passives, such as index funds and exchange traded funds, it’s good to start by looking at the legal risks, as there are still structural differences to consider with both funds.”

ETFs are passive instruments that – due to the way they are structured - allow investors to access most underlying asset classes. They also have the added benefits of being cheap and able to trade throughout the day.

These characteristics make ETFs an attractive option when picking an investment product.

However, there are several things to look out for when picking an ETF.

Firstly, the cost of an ETF may vary.

The Vanguard FTSE 100 ETF is currently one of the cheapest on the market with a TER (total expense ratio) of 0.10 percent. It is physically backed and has roughly £765.50million in assets under management. However, the Source FTSE 100 ETF has a TER of 0.35 percent, which is a 0.15 percentage point difference in cost.

When looking at things like tracking difference and tracking error it is also important to ensure that you are looking at the right index. There is a FTSE 100 index that includes and excludes dividends. You want to make sure that you are looking at the index that includes dividends.

Peter Sleep, senior portfolio manager at 7IM, said: “When assessing tracking difference I think the longer the track record the better, so you can get an idea of how much a fund might drift.  The day to day volatility of the ETFs and trackers should all be identical given the underlying.  You do see differences though in the way funds represent volatility, but I think this arises from the mathematically different ways of calculating it.”

While ETFs are famed for their ability to trade intraday, which sets them apart from most other passive products, not all platforms in the UK have adapted to accommodate this.

“One of the benefits of ETFs is that they trade throughout the day, which offers the investor flexibility. However, platforms are still trying to fix the fact that they aren’t geared up to trade throughout the day. So a lot of these platforms still only have trackers,” said Marchioni.

This matter of costs charged by brokerage platforms may mean you don’t make savings on the actual cost of the ETF.

Sleep said: “Be careful of the platforms custodian charges.  These can add up and make holding any sort of FTSE 100 instrument, ETF or tracker, look very expensive.  Platform charges can be as high as 45bps for small investors – more than quintuple the best priced ETF or tracker.”

Marchioni also said that while UK equities are subject to a 50bps stamp duty, which is paid for creations by index trackers, when ETFs are purchased in the secondary market (on the stocks exchange), they don’t have to pay this.

However, Sleep argued that this is misleading “as the cost of stamp duty is often implicit in the premium to the fund’s iNAV e.g. today the Vanguard FTSE 100 ETF is trading at a 0.44 percent premium to iNAV, reflecting the stamp duty in the cost of creation.”

Tracker Funds

Tracker funds might also be a good bet if you are looking for a long term investment. They are different to ETFs in that they are only traded once a day and they are also subject to stamp duty, but they remain cheap.

The total cost of ownership is one of the most important things to look at when choosing between ETFs and trackers. This is the cost of getting into the fund, host much it costs to hold and how much to get out.

“It is the holding and transaction costs that set a tracker and an ETF apart,” explained Marchioni. “An index fund typically has lower holding costs, but ETFs have lower trading costs and they tend to trade within the underlying baskets’ spread.”

Some FTSE 100 trackers can charge a 40-50 basis point fee up front to cover stamp duty, but some do not and instead pass the cost of buying new shares onto the existing shareholders.  However, they will always charge a management fee each year, which can vary between funds from 0.1 percent to 1 percent

The HSBC FTSE 100 tracker has an annual cost of 0.17 percent and has a five-year return of 99 percent (so if you put in £1,000 you’ll end up with £1,990). However, make sure to buy the right share class or you could end up paying more.

Sleep said: “I used to be able to say that a good tracker is cheaper than a good ETF.  Now the best priced trackers and best priced ETFs are pretty much the same price (Vanguard ETF and the Scottish Widows tracker are both priced at around 10bps).”

The Scottish Widows UK Tracker has a management charge of 0.10 percent and has a five-year return of 84.1, meaning if you put in £1,000 you’ll get back £1,841 at the end of the five years.

However, Sleep argued that tracker funds have a wider range of pricing, so it is important to make sure you do not end up buying a fund that costs 1 percent from Virgin or M&S.

“I would say be careful about some funds who have multiple layers of fees.  For instance some fund managers have an AMC (annual management charge) and then admin charges and other charges on top.  Always check the KIID for the Ongoing Charge and do not look just at the AMC,” he added.

Active Funds

Unlike a passive product, which is designed to track the underlying market, an actively managed fund is run by a fund manager or investment research team who make all the investment decisions and aim is to deliver a return that is superior to the underlying market.

The argument for an actively management fund is that it could outperform the market you are looking to track because you have somebody tactically managing your money. It means that they can react to market movements quickly and move the money accordingly to get exposure to whatever is going up.

However, this is concept that fund managers will outperform the market is not common and the increased costs that active managers charge makes them an expensive proposition.

For example, the SVM UK Growth fund has an initial charge of 5.25 percent and then an ongoing annual charge of 1.50 percent. If you compare this to the Vanguard FTSE 100 ETF or the Scottish Widows tracker fund, which both have a management charge of 0.10 percent - a 6.65 percentage point difference.

If you invest directly with a fund management company then you could see charges soar. However, some of the fund supermarkets – such as Cofunds and Fidelity – sometimes discount the initial charge and trim the annual fee.

Futures

However, despite all this, Marchioni said that the biggest change they are now seeing in FTSE 100 products is between futures and ETFs.

“The open interest in FTSE 100 ETF futures is in the region of $63 billion at the moment and this is interesting because there is a headwind in the market. Futures trading is becoming more expensive since the Volcker rule and Basel have come in to play. It means that figures are now trading above fair value and we are seeing those investors in fully funded, buy-and-hold future positions move into ETFs.”

 

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