MR MONEY MAKER: Active vs. passive: which way to go with your funds?

A history 

Back in 1995 Barclays bought a loss-making fund management firm called Wells Fargo Nikko.

It was based in California and had developed a simple investment idea, which was eventually going to dominate the investment management world.

Exchange Traded Funds – which are focused on a particular index – are effectively traded as an ordinary stock rather than a fund. This means that they are easy, quick and cheap to trade

It had merely worked out that by just buying and holding the same companies in the same proportion as the S&P500 Index (the leading US stock index of 500 companies), it would probably beat most of the much more expensive fund managers on Wall Street.

There have always been ‘tracker’ funds, which as the name implies track a particular index, but these were different. They were called Exchange Traded Funds (ETFs) which, in effect, traded as an ordinary stock rather than a fund.

This meant that they were easy, quick and cheap to trade, instead of the rather laborious process involving old funds and unit trusts. Barclays paid over $440m for this company, which was seen as huge in those days for an unproven unprofitable investment company.

This provided Barclays with around $200billion of new assets. The last figure I saw last year showed that there were now around $7.7 trillion in ETFs.

What can I learn from this?

ETFs have now proliferated around the globe and cover many asset classes and have many variations, but at their core is a very cheap way of investing very broadly across the globe and across those asset classes. 

So from main markets to emerging markets, access is easy. The competition has been fierce and so the competitive charges have come down and made them extremely cost effective (there was even one ETF that paid investors to own it for a while).

And a warning?

Be wary, though, as an ETF simply reflects the index it is following, and that index can often be skewed by a particular sector, such as technology in the Nasdaq, or miners and oil companies in the FTSE 100.

Also, while some ETFs directly hold the shares of that index, others will merely ‘reflect’ them and are thus not direct owners. They are referred to as ‘synthetic’ ETFs and are not as transparent as the direct ones.

What can I do?

Warren Buffett, the highly successful US investor, has previously recommended that for most private investors just buying ETFs is a very efficient way to develop their investments, and I would certainly agree.

Over the past few years an ETF in the main US indices would have done extremely well and better than most professional investors – and at a lower cost.

They are not the solution to all our issues for our portfolio, but they will provide a very valuable, flexible and low cost tool for us all to use.

This post first appeared on Dailymail.co.uk