Expert investors is a series brought to you by ETF Stream where on a fortnightly basis we interview the key individuals from across the fund selection and research space about the ETF ecosystem.

Fund selection plays a crucial role in portfolio construction. Once the asset allocation decision has been made, these individuals need to decide how they want to be exposed, be it through a mutual fund, investment trust or ETF.

Over the years, ETFs have become an increasingly important part of any investor’s toolkit. This series will show how the key players across the fund selection space use ETFs in their portfolios while asking what more can be done by the ETF providers to help with this increasing adoption.

Next in the hot seat is Lynn Hutchinson, senior analyst at Charles Stanley. Hutchinson joined Charles Stanley in 2013 following the acquisition of Evercore Pan Asset. As senior analyst, she analyses both index and ETFs and is responsible for which passive products are included on the firm's preferred and covered fund lists.

How much of your portfolio is made-up of ETFs/index funds?

At Charles Stanley, we have a wide range of models that use both ETFs and index tracking funds only but also these index tracking products are used by some investment managers in their client portfolios or funds depending on where they fit alongside their active funds and direct equities and bonds.

When did you start investing in ETFs? Why then? If not, why not?

I first started looking at ETFs in 2008 when I joined Pan-Asset – a new start up investment management company.

At that time there was not a lot of choice of European-domiciled ETFs although there was a much wider range available in the US.

We wanted to build client portfolios using ETFs as their core allocation building blocks but we also wanted to expand our investment offering to include low cost model portfolios on external platforms using these investment vehicles.

We worked with the ETF providers at the time, and over the following years, to expand their asset class offering to include in the portfolios.

From 2009, the existing and new launches of ETFs really started to take off and it has been interesting to see the growth of AUM and expansion of product offerings since then.

Which asset classes do you tend to invest in through ETFs?

I look at the whole of the European ETF market and we have a broad selection available for portfolio implementation.

I have a preferred list of ETFs and index funds – largely ETFs, but also a covered list to add additional products like sectors, individual country equity and bonds, ESG etc.

The largest allocations have by far been to the developed markets products like the S&P 500 or the FTSE 100 but also quite a bit of interest in the thematic ranges so far.

I include bonds, factors, thematics and some commodity products in the selection – depending on their structure.

Which areas would you avoid?

Some of the hedge fund ETF offerings have not made it to my list – this is an area for active management in my view. We also avoid anything that is leveraged.

Some commodity products that are not UCITS are also not included for retail client portfolios.

The active ETFs will not be included in my lists as these will not be fully rules-based.

What is your methodology for selecting ETFs?

I have a very detailed ongoing due diligence selection before any products make it to my lists – both for inclusion and to remain on the list.

One of my key selection criteria points would be firstly knowing the index – know what you are investing in, what is the selection methodology process (particularly for factor or thematics products).

Is it the right choice for your chosen asset class?  Many products have very similar titles but they can track widely different underlying assets.

The tracking difference is also a major decider – no point in having a low-cost tracking vehicle that consistently underperforms its benchmark returns after costs.

Likewise, a product that consistently outperforms the benchmark without a good reason – withholding tax treaty differences compared to the benchmark is a good reason for this to happen but tinkering outside the rules-based methodology is not good practice for an index tracking vehicle, it could easily go in the opposite direction.

The number of authorised participants (APs) or market makers covering the ETF – the more the merrier as this can help keep the bid/offer trading spreads narrower than others offering the same product with less stock market offerings – a wider trading spread can be a big negative for performance returns, particularly for tactical trading.

Domicile of the passive product – in terms of withholding taxes etc. as different product domiciles may have different tax treaty agreements with other countries.

Assets under management (AUM), although important – because you do not want the risk of the ETF being closed and being left out of the market – is not a major key selection criteria as in the past we have been involved in the seeding of new launches. Although this does also get monitored regularly.

Do you have an ETF provider preference?

There are some ETF providers that obviously offer a premium service over others. Easy to navigate, user-friendly websites always help.

The level of service in reporting information from the sales or investment teams is also a factor. Having the ability to obtain information timely on request on products and the index being tracked is a key provider service.

What ETF products would you like to see more of?

While there is a huge growing selection of ETF products available there are in some cases too many tracking the same index – S&P 500 is one of them.

I would like to see more offerings in the bond products. At this point, it would be good to see some corporate bond ETFs that exclude BBB bonds or a methodology other than market cap weightings selected.

Previously, we wanted to see more ESG or SRI products but now I fear the European market is becoming saturated with them too – most doing something slightly different to the other but not making a huge difference ultimately in returns.

Are there any areas ETF providers could improve?

There is no doubt that the education has improved dramatically over the past few years from most ETF providers but there is still work to be done.

Improvement on ETF trading through platforms is still way behind what I would like to see. There have been ongoing discussions with ETF providers and platforms providers offering ETF products but this for some is still woefully lagging the times and has been dragging on for years without much improvement from what I can see for some platform offerings.

The European stock markets listings have multiple listings of ETFs across them and it would be good to finally see a combined report of ETF trading across all European stock exchanges.

To read the previous edition of Expert Investors with Jeremy Ward of Coutts, click here.

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