045 | Dividend-based ETF investing

In order to consider the viewing of Akademia videos as structured learning, you must complete the reflective statement to demonstrate what you have learned and its relevance to you.


  • James Kingston, Vice President of iShares

Learning outcomes:

  1. The importance of diversifying an income portfolio
  2. Why using ETFs help to create a sustainable income strategy for clients
  3. How altering the asset allocation mix can tilt the risk reward characteristics of a portfolio

The Matter of Income: A Multi-Asset ETF Approach


Asset Management
PRESENTER: Hello and welcome to this Akademia session on using ETFs for income investing. I’m Mark Colegate and to discuss the topic I’m joined now by James Kingston. He’s part of the Investment Strategy and Insights team at iShares. James, I mean income’s important to all of us, but just before we get into this topic in a bit more detail, give us the background, where is the income story at the moment? JAMES KINGSTON: It’s come a long way in the last five years and income isn’t a new theme for us to be talking about. So we’ve been worried about income yields for a long time; we’ve seen suppression across government bonds, credit, high yield; cash rates in a lot of Europe are negative; government bonds on the short end of the curve are negative in a lot of places too. So we really have to think about where we get our yield from, where we get our income from, outside that box. Thinking outside that box we try and generate income from elsewhere. PRESENTER: And does that mean we have to take more risk to get a level of income which might have been if you like fitted as standard ten years ago, or is it about more risk? JAMES KINGSTON: It’s about different risks. So potentially you might have to add more risk to your portfolio, yes, to take, to get the initial income, but diversifying your portfolio to get more types of risk in there is also a good thing as well. PRESENTER: And I mean how can you diversify, I mean beyond buying equities what else is there? JAMES KINGSTON: So we think about equities broadly, but there’s also equity strategies that focus on dividends, particularly, and we use those a lot in our own strategies internally and we talk a lot about that with our clients. Beyond that there’s also alternatives in the equity space, so real estate is a really good example as providing sustainable yield on an ongoing basis that will give you the income in your portfolio. Infrastructure’s another example. Defensive sectors is a good way, like utilities, to get income, so there are many other options other than just fixed income to get income into your portfolio. PRESENTER: And just sticking with the equities very very briefly if I may, what’s the track record of equities on paying out dividends when times get tough? Do they continue to pay those dividends? JAMES KINGSTON: Well if you look at the stability of dividends in the MSCI World, for example, the standard index for developed world equities, or the EM index, they’ve been relatively stable over the last five years. In fact EM they’ve actually increased marginally. If you compare that to where yields have been on a fixed income, they’ve been decreasing across that time. In comparison, it’s a fairly attractive proposition. PRESENTER: And then quickly back to fixed income, because we sort of moved off that very fast, you’ve talked about this yield compression that’s been going on, how high risk in general terms are corporate bonds and high yield bonds these days? JAMES KINGSTON: Well we talk about different types of risk rather than overall risk, so there are different risks in high yield. There is that risk from investing into a lower grade investment vehicle. But that has been pretty good of late. Well it’s a really bad thing to say, it’s not as bad as you would think, and we’ve seen a lot of flows into high yield over the last few years, which is really showing the popularity of that theme with investors in the ETF markets. PRESENTER: And how do you work out as an investor that you’re being sensible in diversifying your income rather than just your chasing yield? JAMES KINGSTON: It’s the same with any diversification exercise with any portfolio don’t put all your eggs into one basket. So, if you’re considering your yield target and where you want to achieve, look at what’s available to you, assess the risks of those individual exposures. So one fixed income exposure might have credit risk, the other might have rate risk, equities carry their own risks. So understanding what you want to include in there and what your overall max levels are for what you want to be included is important in setting your allocations. PRESENTER: And is that something an adviser can do themselves on behalf of their clients, because it all sounds quite complex and you’ve got to have a bit of an inside track to know all this? JAMES KINGSTON: There are a number of solutions that are available in the market from ETF providers, so model portfolio solutions, and they’re available through different networks. Advisers can also do this for their clients. So we’ve developed or we work to a four-stage principle process when we’re building our own model portfolios. The first step being trying to ascertain what your goals are and trying to think what your constraints will be. So what am I trying to achieve and what’s the risk I’m willing to take to achieve that? Secondly, what’s the investment universe that’s available to me, and that’s considering all asset classes, and those two kind of go hand in hand, but they’re also interchangeable. So sometimes you’ll start with what’s available and see what you can achieve from that. The third step is the most important step, because that’s defining your allocations, and we always see it as two different options there. One’s taking a quantitative approach, systematic, so some sort of mathematical optimisation process, which a lot of the model portfolios in the market will do, or there’s more of a qualitative approach, so building from the ground up based on your own knowledge of those markets and allocating as to your own preferences, your own particular views on those markets. PRESENTER: I mean you’ve discussed the framework that you’ve got at iShares, how accessible is that to advisers? JAMES KINGSTON: Our process or generally? PRESENTER: Well let’s talk process in general, but I mean use yours an example. JAMES KINGSTON: So the process that we’ve got we’ve put into a paper that we’ve written, and that’s available for anybody to read. And that really details our understanding and our beliefs when we’re building these sorts of portfolios, these ETF portfolios. And I would think that the majority of advisers who are using ETFs in income portfolios would be following a similar sort of procedure when understanding how to include these particular exposures in their income portfolios. PRESENTER: And that I think is this one here, which we’ll have on the bottom of the player, so do keep an eye out for that. Okay. And having gone through that four-stage process I mean obviously the crucial thing here is looking at risk, and you said there are different types of risk, what are the key ones to consider? JAMES KINGSTON: Okay, so I’ll start from scratch if I can on diversification, because what we’re trying to do in an income portfolio is diversify our risks, but also diversify the sources of income. So for instance if we were holding a portfolio G7 government bonds back in 2007, we’ll be getting about 2% yield ish. Now we’d be getting around 1%, maybe a little bit less. So the need to diversify if you have a 2% target on your income is plain and clear from the way we’ve seen yields go in the last few years. And if we consider then a portfolio which we can diversify with corporate debt and emerging market debt, for example, and then a third portfolio where we can diversify with equities, if we compare those three in terms of yield, the last portfolio with the equities is now above 2%. It’ll be around the 2% mark as of the end of last year so you’ll be hitting your target. In terms of total returns, introducing equities gives you that capital appreciation that you really have to consider when you’re building your portfolios. And from a risk perspective a portfolio holding with just government debt will be overexposed to rate risk of those countries. So if rates were to rise you’d be exposed to that particular risk. If you then introduced corporate debt and EM debt you’ve got the additional risks of that, but you’re not so worried about interest rate risk rises. And again if you introduce equities you’ve diversified those risks further so you’re not so worried about the other risks in the portfolio. Now marginally it might increase the total volatility of that portfolio overall, but because you’ve diversified your risks you’re in a happier place because you’re less worried about one particular type of risk. PRESENTER: Okay, so we talked about the importance of diversification, but how do you get this balance between yield, yield growth, total return? JAMES KINGSTON: It is a balancing act, and that’s one of the key aspects you’ve got to think about when you’re building the portfolio, so we see it as a four-step process. But within that four-step process you’re balancing what’s my yield target, so picking the exposures that are going to get me to my yield target. But also picking the exposures in the markets that are going to exhibit growth so that my yield doesn’t get eroded by inflation over time, and then making sure you’re including the exposures that are going to give me capital appreciation. I don’t want my portfolio to pay all its income and I’ll be left with nothing because it’s decreased in price, or not increased as much as I would like. PRESENTER: So a key thing here is to think about the long-term strategy for generating income. JAMES KINGSTON: Yes, absolutely, you have to think in a long-term strategic sense, and building a diversified portfolio across multiple asset classes allows you to do that. PRESENTER: And how can you make a healthy stab at what inflation is going to be in the future, because that must have some impact on how much risk you’re prepared to take with your yield today? JAMES KINGSTON: But that’s a difficult question to answer, I think most economists probably agree with me on that. There are a number of exposures that you can get in the fixed income space debt that for instance will give you a hedged exposure to inflation, so inflation-hedged exposures. Equities are a good inflation hedge as well, so incorporating that into the portfolio will allow you to mitigate in part inflation in your portfolio. PRESENTER: Well, James, you talked a lot about diversification, but presumably as we all invest in broader and broader parts of the world this brings currency in as a source of risk and reward that perhaps wasn’t the case 20 years ago when most people stayed much closer to their home market? JAMES KINGSTON: Potentially, so a lot of the portfolios that we run, for instance our GBP portfolios, a lot of the portfolio will be dominated in GDP, so we won’t have that much FX risk. Same with a euro portfolio, we’ll try and make sure that a lot of that denominated in euros. Invariably though there are going to be exposures that will not be in those currencies, so there will be a little bit of FX risk. If that’s a particular concern to an investor then there are exposures available that hedge that risk explicitly within the fund. So you can get exposure to a particular asset class without the FX risk. PRESENTER: So, if you’re buying an ETF, it’s very easy to buy a sterling or a euro or a US dollar share class version of it? JAMES KINGSTON: We haven’t got the share class model, most ETFs won’t have a share class model, so there’ll be one ETF on one particular index, but increasingly a lot of providers are launching additional ETFs on the same index. But a hedged version of that index so that FX risk is then mitigated in that exposure. PRESENTER: So it’ll be FTSE sterling, FTSE US dollar, FTSE euro. JAMES KINGSTON: For example, not maybe in FTSE, but other exposures, but there are more and more of these in the market, and it’s becoming more topical for the ETF market. PRESENTER: One thing you’ve mentioned everyone’s been very interested in income investing particularly now rates are so low, but doesn’t this tell you that the next thing that’s going to happen is rates are going to be much higher? So in 15 years’ time will everything you’ve been talking about now still make sense if base rates are say 6%? JAMES KINGSTON: So another important consideration when you’re building that portfolio is the four stages of monitoring and reallocating. So making sure that your portfolio’s in line with your objectives at all times and then making any necessary adjustments. So if rates were to change you can adapt to that if necessary. And if you want to make a longer term investment and you don’t want to worry about making that adjustment when rates do rise then choosing exposures in the ETF space that are interest rate hedged for example will get you past that issue, because they aim to mitigate in part the interest rate risk. PRESENTER: Well let’s move on to ETFs specifically, I mean this has been a really strong growing part of the market in the last few years. If you’re an adviser or an investor how do you navigate your way around it? JAMES KINGSTON: The ETF landscape has grown markedly over the last 15 years. So take fixed income ETFs, which are relatively compared to equity ETFs, they’re now over $450billion globally in terms of assets. If you think about a traditional income portfolio that would normally consist of fixed income instruments, providing a regular coupon. So analogous to that if you use ETFs, fixed income ETFs will be the cornerstone of your income portfolio. That’s not only driving the growth in fixed income, obviously providing access to fixed income markets which are non-exchange traded, a little bit in a transparent way has driven a lot of the growth in that particular market. But we’re using fixed income ETFs in our income portfolios and a lot of investors are doing exactly the same thing, so using government exposures, using corporate exposures, if you’re looking to find more yield, emerging market debt high yield to increase the yield in your portfolio. But the market is so large and picking those particular exposures are very very difficult. So you’ll find that ETF providers like ourselves will have guides on our website as to what ranges we have and slicing and dicing it in different ways to provide a little bit of assistance on how to navigate that particular world. PRESENTER: And I suppose most people are familiar with ETFs in terms of providing very specific single exposures like to a country or an asset class, but are there more now than if you like our almost like multi-asset ETFs, is that a growing space? JAMES KINGSTON: Multi-asset ETFs not so much, but multiple asset ETFs, yes. So fixed income is growing, equities is always going to be big. The big innovation at the moment is around smart beta, so new types of strategy, so moving away from the traditional market capitalisation weighted. So we’ve launched recently a suite of factor ETFs in the equity space. So to try and take advantage of factors that exhibit long-term risk premia and you get outperformance versus the market benchmark. So there’s been more innovation in the market I would say in that space and we’re seeing innovation on the fixed income side too through interest rate hedging, through duration products, and more products on the commodity side. So across different asset classes more options are becoming available to be able to use in your portfolio, not necessarily all for income, but some will be. PRESENTER: And you mentioned factors there, I mean is that something like well the small cap effect? JAMES KINGSTON: Yeah. PRESENTER: Or ability to grow dividends over time? JAMES KINGSTON: So there are a number of style based factors that we look at that that provide a longer term outperformance in terms of risk-adjusted returns versus the benchmark. So we’ve got factors on MSCI World and MSCI Europe, for example, which look at momentum, minimum volatility, the size factor, the value factor and the quality factor, which all exhibit a measure of outperformance over time, and lets you take advantage of those particular factors in your portfolio. Another factor you might consider is dividends, so there’s also a suite of dividend ETFs, which focus on identifying the securities in a particular market that are paying long-term dividend, which are quality dividends which are sustainable, and using that in a portfolio rather than just a broad equity index will give you a high dividend yield and a very sustainable yield. PRESENTER: And you mentioned fixed income, what are some of the changes there, because traditionally with a fixed income index you get the biggest exposure to the company or the country that’s got the biggest amount of debt? JAMES KINGSTON: So we’re seeing more and more fixed income products on different markets and slicing the market in different ways. So we’ve seen the broad exposures. We’ve got euro corporate AG for example, which provides access to euro corporate debt. So we’ve seen the broad exposures, then slicing and dicing those markets in different ways. Taking advantage of the different characteristics and different parts of the yield curve for example or introducing hedging mechanisms into the index to mitigate certain risks. Those are the innovations we’re seeing in fixed income and it’s having a huge impact on the market. PRESENTER: And what about use of ETFs in some of those alternative investment spaces like infrastructure and so forth that you were talking about earlier? JAMES KINGSTON: Yes, so we’ve noticed that for instance global infrastructure plays a higher dividend yield versus a global equity index over the long term, so that will enhance your yield of an income portfolio. Innovations in the real estate space, for example, are now providing access to indices which are better proxy real estate. So traditionally through ETFs you’ll access real estate through REITS, which have a lot of equity exposure. So you get equity fluctuations in the price, but also that’s impacted by real estate prices as well. Innovations that we’ve been working on, such as the MSCI US product on property, proxies real estate far more accurately and gives you a better yield for your portfolio and an income portfolio. PRESENTER: And, as we look at all of this choice, how are you finding advisers are using ETFs in the last couple of years? JAMES KINGSTON: Traditionally, ETFs have been used as a satellite approach, so using it within an existing portfolio to get certain exposure to certain markets. Traditionally, that’s the way it’s been used. We’ve seen more advisers using ETFs as a core investment now. So building core investments of ETFs that will be in the middle of their portfolio and then supplementing that with other managers to enhance the return, enhance the alpha above their benchmark. Typically, with income portfolios, you’re trying to achieve an absolute performance. You’re trying to achieve a specific yield, so you may not necessarily be benchmarked to something. So it’s about choosing the right products in the right way, be it passive, be it whatever, to achieve the yield that you actually want to achieve for the risk that you’re willing to take. PRESENTER: So there’s still a certain amount of blending, active and passive, I mean, but advisers have got a range of ways of using them, there’s no right or wrong. JAMES KINGSTON: There’s no right or wrong. There’s a vast variety of tools available to us as investors: there’s ETFs; there’s index funds; there’s active funds. And utilising all of them together in a blended way is arguably the best approach, because you’re getting the best of both worlds. PRESENTER: And how often should you look to review your blend, because you create your portfolio of different ETFs, they’ll all be rising and falling and altering your asset allocation day by day, hour by hour, how often should you rebalance? JAMES KINGSTON: So our income portfolios we look at on a quarterly basis just to make sure that they’re in line with target and they’re not going outside their objectives or their risks. It doesn’t necessarily mean you have to reallocate. So if you’re still within your constraints and you’re still working fine then hold onto your allocations. Don’t incur the costs of trading just because you think you need to reallocate. For example, one of our portfolios we looked at it, if you didn’t rebalance, this is a portfolio that comprises equity, diversified fixed income and government bonds, if you don’t rebalance that portfolio over a two year period your allocation to equities can increase by up to 10%. So if you’re not monitoring that then the risk dynamics of your portfolio’s going to change markedly over that period. So it’s really important that you are looking at it and understanding what’s going on. PRESENTER: But, given all this choice, how important is it to do due diligence? I mean not all ETFs are the same. JAMES KINGSTON: Oh it’s very important. That’s something that we’ve talked a lot about with our clients. A couple of years ago we wrote a paper called ETP Due Diligence, so what we thought the main factors were that you should consider when you’re picking an ETF. And given that the ETF industry is so large now and there are so many providers and so many different exposures understanding those providers and those exposures is key. So understanding your index is a very important part of it. So if you look at what you want to achieve in terms of your investment, what are the exposures that are available to me? So for instance very simply if I want to invest into UK equities do I choose FTSE UK, so the FTSE 100 or do I choose MSCI UK? So what are the differences between those two? How are they constructed, what’s their coverage, how do they work so that I’m actually achieving what I want to achieve. An important point to note here is like some index providers treat markets in different ways. So if you think about emerging markets, MSCI and FTSE treat Korea very differently. So if you want to make an investment into emerging markets knowing that fact is important. PRESENTER: So what South Korea is in one of those indices, but not in the other? JAMES KINGSTON: Yes, so it’s in MSCI, but it’s not in FTSE. It’s considered to be developed under FTSE. PRESENTER: Right, okay, so that’s one area there and then say you’ve got through all of that process as an adviser, you’ve still got all these ETFs out there, how do you go about picking the right ones and building a portfolio for your clients? JAMES KINGSTON: It’s a filtration process; you have to start from the beginning. You understand what your asset allocation looks like, what exposures you want. Then you might look at the market and see right these are the providers that are providing exposures on this particular market that I want, I want this exposure, and then your due diligence process starts. So as I said earlier what’s the difference between those indices and then for the competitors or for the ETF providers looking at the listings that are available, the domicile of the ETFs. Price is always going to be a very important factor. But not considering just TER by itself, because you’re not really getting the true picture of how the ETF is performing. So actually looking at the performance of the ETF relative to the index, and then you’re really capturing all the effects that the fund has such as securities lending in it to understand what the holding cost is, and of course understanding the trading cost. So if one particular fund has got a large spread on exchange you’re going to pay more to trade it than one with the narrow spread. So understanding all those different things will make you more aware of what ETF is going to be suitable for you for that particular investment, and then you can narrow down your universe and you can make your selections far more easily. PRESENTER: But what happens if you’ve done your due diligence, there’s an exposure you really need for a client, but you can’t find it, what do you do then? JAMES KINGSTON: This is where the benefit of ETFs really come in. So one of the benefits we know about ETF is their building block type approach. The other benefits that we talk about - like transparency, cost efficiency - they’re very well-known and talked about. The fact that ETFs slice and dice their markets into many different ways means you can piece them together if you want to get a particular exposure. We’ve got a really good example in the paper that we wrote when we’re trying to get access to global equities. PRESENTER: Well let’s bring that diagram up on screen now. Okay, talk us through what’s going on here. JAMES KINGSTON: So in this particular case we want to build an equity dividend portfolio that is diversified like a global equity index. So in this particular case we took the MSCI All Country World Index, and we want to try and create an equity portfolio that is focussed on dividends that will increase our yield of that portfolio whilst maintain the same diversification as the equity benchmark. So what we can do is take the breakdown of that index and then map regional dividend indices to that breakdown and then combine them together into a portfolio that will give us the exposure that we want. And by doing that we actually can raise the dividend yield of, say, if we took MSCI ACWI, we can move it up by about 1% for a lower volatility. So we’re achieving two things there: we’re increasing our yield of the portfolio and we’re reducing our volatility. Now there are a number of products out there that already exist on global dividends, but this sort of approach allows you to change the weights if you have a particular view on a particular market. So if economists are saying that dividends in Europe are going to be strong you might want to overweight Europe in that portfolio to get a better dividend yield. PRESENTER: But what you say to someone who said well that’s all fine in theory, but it looks like a disproportionately large amount of work and cost for what the client’s going to get back? JAMES KINGSTON: It’s not an optimised solution, so you don’t have to sit there and do loads and loads of maths to do this. All you need to be aware of is the breakdown or the diversification of that global index, which is available for most ETF providers through their websites, and then build your portfolio in line with that. So it’s actually very straightforward. PRESENTER: Well, James, we talked earlier about the sort of dilemma of how much yield, how much income do you want now. Let’s talk through an example. You’ve got a global income portfolio, how does tweaking the various factors in it have an impact on what your client’s likely to get? JAMES KINGSTON: That’s exactly something that we looked at. So we wanted to understand how changing allocations in a portfolio will move you up the efficiency frontier, so taking on more risk from more yield. An example that we looked at, we looked at building a very generic global portfolio, so we don’t want to make it specific to any one investor. So we’ve taken global corporate bonds, global government bonds, global high yield debt, mix that in with global real estate and global equities to give a truly global portfolio, but across multiple asset classes. So when we’re talking about building multi-asset class portfolios, we’re not just talking about it, we’re actually doing it all the time in our day jobs at BlackRock, but this is an example on how you actually do it in practice. And now in reality for any particular investor, if you’re in the UK, if you’re in Europe, you might not have a global portfolio, you might want to skew it towards your home risks basically, you don’t want to be taking the risks of other countries on, but in this particular case study we’ve looked at building that portfolio and then by changing the allocations from the high yielding, high risk exposures, change that so you can actually move up that risk frontier. PRESENTER: Let’s bring the first one up. So you’ve got maximum income. Is this the highest yield, the highest risk? JAMES KINGSTON: Within our constraints it’s the highest yield, highest risk maximum Sharpe ratio portfolio that we can create. So it’s a very simplistic way of looking at this, but it’s really highlighting how you can change your allocations to meet your needs. So in this particular case we’ve looked to force a lot of those exposures to maintain our diversification. So we want a minimum of 5%, a maximum of 20% in each of those exposures. And then we looked at the max income, minimum risk and then the max Sharpe ratio. PRESENTER: So what do you do in the minimum risk portfolio then? How does that differ? JAMES KINGSTON: Well we’re looking to combine all our exposures in our investment universe to try and create a portfolio that will give us our yield but for the least amount of risk. So by doing that we’re actually pushing a lot of the assets into the less risky assets, so government bonds, corporate bonds, less equity, less high yield, less emerging markets. PRESENTER: And when you say risk what’s your definition of less risk then? JAMES KINGSTON: This is based on volatility, so we’re looking at total risk, so total volatility. We’re not looking at the insides of the portfolio, so how that breaks down into the different types of risks. But with the portfolio that’ll be dominated by government bonds, it’ll be dominated by interest rate risk in the portfolio. As we move up the spectrum and we introduce more emerging market debt, more high yield debt, we’re going to be diversifying our risk as we talked about earlier. We’re going to be pushing ourselves up in terms of more volatility, but we’re getting more yield. So in these portfolios we go from around 2½% in the low risk portfolio to around 4% maximum in terms of the yield that we can achieve within these constraints. PRESENTER: And then just finally quick focus on the maximum Sharpe ratio, and first of all run through why’s the Sharpe ratio so important anyway? JAMES KINGSTON: The Sharpe ratio gives us an idea about the overall risk return. So on a per unit or risk basis how much return am I getting? So if you want to think about taking risk, how much return can I get for the risk I want to take? So we use Sharpe ratio a lot when we’re thinking about portfolios, because it’s a very efficient way of thinking about this. So the Sharpe ratio here is looking at the total return of the portfolio, whilst we’re obviously trying to get a certain amount of yield. So this is balancing again the whole concept of total return versus yield in the balancing act we were talking about earlier. PRESENTER: Well then if we bring up our scatterplot which shows sort of the risk of all characteristics of each of these three portfolios, what’s it revealing? JAMES KINGSTON: So it’s revealing that for around a risk of around 7% you can achieve a yield of around 2½% for the universe that we’ve used. If you’re willing to push up your total risk to around 9% you can achieve almost 4%. Now of course this is constrained. We’ve put constraints on these portfolios that we only want to have a maximum of 20% in any one particular exposure. If we’re willing to take more risk in for instance high yield or emerging market debt we can push that out even further to get a higher yield, but of course at the expense of more risk. PRESENTER: Yes and is this a case then of saying that the longer the timeframe you’ve got the more risk you can afford to take and it will work for you or it should work for you in terms of generating a higher income over time, although there might be some blips along the way? JAMES KINGSTON: It’s also down to your circumstances. So depending what the income for and what the portfolio is trying to achieve, depending on whether you’ve got a short-term horizon or a long-term horizon, you should be taking less risk or more risk effectively. PRESENTER: It’s interesting what you said earlier that a lot of investors might well have a home bias and I mean this is a worked example, it’s truly global, from the research you’ve done should people have a home bias or is that just a behavioural trait we’ve all got and we just live with it? JAMES KINGSTON: It’s a bit of both. So a lot of the clients that we speak to, a lot of the portfolios we look at will naturally have a home bias. Primarily because that’s the market you’re familiar with, that’s the market you know, but also because you don’t want to be exposed to somebody making decisions halfway round the world. But that being said having that diversification is very important because if things are happening in Europe you want to be able to get your yield from somewhere else. So creating a balance between maintaining a diversified portfolio, but making sure you’re keeping in line with your priorities and if that is your home market then it’s your home market. PRESENTER: As an adviser say you think right I can see why this all works, how easy is it to explain to your client, because ETFs you don’t hear people chatting about ETFs on the street day in day out. JAMES KINGSTON: More so you do. PRESENTER: Oh well we obviously take very different tubes to work, James, you know, but it’s not common I suppose in a way that somebody might know what Tesco is as a stock. And equally as you’ve said you can get an extraordinary range of diversification, a whole range of things that you can invest in, isn’t that likely to put the end consumer off? JAMES KINGSTON: I think if you look at the European market and compare it to other markets in the US, so the US market is very driven by personal investing. A lot of people use ETFs themselves. In Europe, we’ve got a different mentality I think. And depending on what country you go to, you might see again different mentalities on how people invest. Be it buying property, in the UK we like to buy a house. If you go elsewhere in Europe, they don’t buy houses, they invest. So depending on where you look different people have different trains of thought. ETFs are increasingly becoming used by more clients in the retail space, so the end investors. Institutionally a lot of clients are using ETFs as well. So the growth of them in multiple areas of finance is increasing and the increasing knowledge is only going to fuel that and grow that even further in the future I think. PRESENTER: Well, James, if we can start to pull some of these strands together from the last half hour. In summary, how do ETFs help advisers to meet this ongoing income challenge? JAMES KINGSTON: Well I think it’s an important fact to note that all investors are different, all portfolios are different. Everyone’s going to have different needs and different constraints. And being able to use tools that are available to you that you can create very bespoke tailored portfolios that you can change as the needs of those clients change is very important. And having the transparency and the cost efficiency to be able to look through into that portfolio understanding exactly what’s going on, what you’re holding at any one point in time and making changes quickly, efficiently and easy, makes ETFs a perfect tool for being able to do this. PRESENTER: So that’s all very well and good, but it’s a huge market, there’s a lot of complexity in it, it’s not worth me taking the time to understand what’s going on. JAMES KINGSTON: Speak to the ETF providers. They’ve got overviews of their ranges; they can help you understand what they have on particular markets for your particular needs. Looking at research reports as to what the best ETFs are in particular markets, that helps – I lost what to go next after that. PRESENTER: We might lose that last sentence. JAMES KINGSTON: Sorry, yes. PRESENTER: You know, do you want to just do that answer again? JAMES KINGSTON: Let me answer that again. PRESENTER: Because I don’t think it has to be a long answer, I think you just need to say it with more conviction, because as you were saying it I could see you thinking I need something to bring it together. JAMES KINGSTON: I’ll try and think of something else. PRESENTER: And you just sounded a bit down on it. And what you said was fine, but I think you just said it’s really simple and then gave a short answer, that’s probably. But what would you say to those advisors who say well it’s a huge market, there’s a lot of complexity in it, it’s just not worth trying to understand it? JAMES KINGSTON: It’s a huge market because there’s so much choice available and it’s actually really easy just to look at a website that summarises all that in one go. If you’re looking for a UK tracker, a UK ETF, look on one of the providers on the website. It’ll show you all the ETFs that are available, you can go through them, understand which ones are performing the best, choose your provider or choose your range of providers, and then talk to those providers. Understand how they work, what they’re doing, whether you want to work with them, and that’s the best way to go forward when picking an ETF. PRESENTER: And just thinking of some of those models, examples that we were looking at earlier, I mean how easy is it to tweak those asset allocations as your clients need changes over time? JAMES KINGSTON: ETFs are designed to be easily tradable. They’re all on exchange; you can buy them and sell them very easily. So if you’re looking at a portfolio and you want to make a quick change you can trade almost instantly, you don’t have to wait till the end of the day, you don’t have to wait until next week. It’s very easy to do and they’re designed to be that way. PRESENTER: But what sort of costs are involved, because we hear a lot that, you know, if you overtrade a portfolio you leak quite an alarming amount of performance over the long term? JAMES KINGSTON: Well the ETFs are subject to the spread that’s on exchange. So that’s the difference between the cost you buy and the cost you sell. So for ETFs that are trading a lot are very liquid, debt spread will be very very narrow, so the on exchange spread will be cheap. PRESENTER: Sorry, when you say very narrow is that a matter of what two basis points? 30? JAMES KINGSTON: For some of the very developed MSCI World products it can go down to a very small amount like that yes. For more illiquid products or for ETFs that aren’t traded as often they might widen a bit. So understanding the products that are available like we said earlier and seeing what the spreads are will help you make you choose which products are right for you. You might have additional costs through brokerage costs to actually trade it as well which are important to consider in your whole decision-making process. PRESENTER: But as a rule of thumb if it’s more illiquid try and trade it less often, would that be the sort of basic rule? JAMES KINGSTON: Yes, but any basic rule of running a portfolio is to not turn it over too much, because you’re going to introduce so much cost into it, you’re going to drag on your performance. So making the right choices and doing your due diligence from the start is very important. PRESENTER: And finally ETFs are very popular now, any proof that they will be equally popular in 20 years’ time, because a lot of clients have been invested for multiple, a couple of decades not just today. JAMES KINGSTON: Well if you look at the growth of ETFs over the last 15 years year on year they’ve been growing, the number of products available have been growing. We’re doing a lot of work on innovation, on new types of products, which are proving to be very very popular. Just through speaking to our clients and looking at research surveys in the market and showing that more clients are starting to use ETFs alongside other products in the core of their portfolio, long-term strategic holdings. So over the long term we foresee it’s only going to grow in the future. PRESENTER: We have to leave it there. James Kingston, thank you very much. And thank you for watching. Do stay with us. We’ve got some learning outcomes coming up next and a bit of information about how you can use that as part of your structured learning when it comes to CPD. In order to consider the viewing of this video as structured CPD, you must complete the reflective statement to demonstrate what you’ve learned and its relevance to you. Among the topics covered in this Akademia workshop are: the importance of diversifying an income portfolio; using ETFs to create a sustainable income strategy for clients; and how altering the asset allocation mix can tilt the risk reward characteristics of a portfolio. Please now complete the reflective statement to validate your CPD.