Investment trusts rely on ETFs as ‘efficient asset allocation’ tools

Being low-cost and liquid is attractive for actively managed products

Jamie Gordon

Active managers around a table

The low cost and highly liquid nature of many broad-based ETFs make them an ideal weapon in the arsenal of active strategies, a fact not lost on the investment trusts which are turning to the wrapper as an efficient means of capturing certain exposures.

Because ETFs trade on the secondary market and can be executed intraday, they are a perfect tool for investors looking to efficiently manage risk and liquidity.

This is the significant difference to mutual funds which only trade on the primary market with their net asset value (NAV) calculated at the end of the day. This can lead to risks such as gating when a mutual fund suffers a string of significant redemptions, for example.

One proponent of ETFs is the FTSE 250-listed Capital Gains Trust (CGT) which allocates 9.9% of its portfolio to 10 ETFs from BlackRock, State Street Global Advisors (SSGA), Amundi and Vanguard targeting regional and single country exposures, energy and resource sectors and value factor equities.

Richard Goody, risk and compliance director at CG Asset Management, told ETF Stream: “We tend to use ETFs to gain exposure to broad target markets or asset classes as they have low charges and an excellent liquidity profile.”

ETFs currently comprise CGT’s two largest equity allocations, with their role in the multi-asset trust’s portfolio growing in recent years.

“Over the last five plus years, we have increased CGT’s allocation to ETFs to current levels. We do not anticipate it increasing further. I am fairly sure there are other investment trusts that have acted similarly.

“Generally speaking, CGAM would tend to be buy and hold investors. However, we may decide to swap between ETFs to focus the fund’s exposure on exactly the right pool of underly[1]ing assets.”

A more tactical approach

Elsewhere, other trusts are using ETFs as low-cost building blocks for broad equity exposure. Hansa Investment Company Limited (HAN), for instance, invested 6.5% of its portfolio in the iShares Core S&P 500 UCITS ETF (CSPX) and 4.1% in the iShares Core MSCI Europe UCITS ETF (IMEU) at the end of August.

Meanwhile, the New Star Investment Trust took a more tactical approach in March with its 3.1% allocation to CSPX, a decision made “after falls by US stocks in January and February”, the company said in its end of year results in June.

Also using ETFs as a tool for tactical asset allocation is the independent rival to Baillie Gifford’s Scottish Mortgage, the Manchester & London Investment Trust (MNL). Mark Shephard, founder of MNL, told ETF Stream his company allocates under 5% of its portfolio to ETFs capturing the S&P 500 and Nasdaq 100 as a means of hedging its other exposures.

An efficient toolkit

Elsewhere, ETFs play a modest role for top-twenty-ranking Witan Investment Trust (WTAN), which targets an individual investment theme with a 0.62% allocation to the SPDR S&P Biotech ETF (XBI).

Explaining why ETFs have become a popular tool used by investment trusts and other actively managed structures, Henry Jim, ETF analyst at Bloomberg Intelligence, said: “Tonnes of active products use ETFs, including a trend follower fund that recently filed in the US that rotates between broad market baskets of equities and treasury bonds.”

Jim stated a fund with a rolling exposure would historically use futures or swaps for broad expo[1]sures, however, they then have to roll these, put up collateral and potentially face liquidity constraints.

“With ETFs, they can just go in and out. Instead of buying futures and having to roll them every month, they just buy an equivalent ETF.”

On the potential eyebrow-raising toward investment trusts using index-tracking products, he concluded: “The way to look at it is not ‘this is active so why is it investing in passive products?’. But rather, ETFs have become an investment tool not just for investors looking for performance but also for efficient asset allocation.”

This article first appeared in ETF Insider, ETF Stream's monthly ETF magazine for professional investors in Europe. To access the full issue, click here.

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