Three sectors where passive trumps active

Around 200 new exchange traded funds (ETFs) available to UK investors launched in 2016 alone, so investors can be forgiven for feeling a little overwhelmed.

With so many competing products, it has never been more difficult to select the right funds for your portfolio.

To help, Morningstar has recently launched analyst ratings for ETFs. This qualitative and forward-looking rating harnesses the same 'five pillars' methodology used to evaluate traditional actively managed mutual funds, in which funds are scored on process, performance, price, people and parent.

Interactive Investor's Rated ETFs 2017 revealed

As analysts, this gives us the flexibility to direct investors to the funds we hold in the highest regard, irrespective of the vehicle, within a given market.

It is well-recognised by professional investors that passive investing is a 'no-brainer' in some markets, but is less attractive as an investment in others.

Below we highlight three sectors in which we feel investors may be best served by 'going passive', and the ETFs tracking those markets for which we have awarded a Gold analyst rating, signifying our highest level of conviction.


Vanguard S&P 500 ETF (VUSD)

This highly popular ETF physically tracks the S&P 500 index, the most oft-cited proxy for the US equity market. The fund has all the strengths we would associate with the very best trackers.

The ultra-low annual fee of 0.07 per cent means this fund is one of the cheapest of all S&P 500 index funds and ETFs.

The US large-cap equity market is widely considered to be one of the most efficient and liquid markets in the world.

This belief is supported by a large body of academic research questioning the value of active managers in the space. Currently, no active funds have received our Gold analyst rating in the US large-cap market.

It is therefore unsurprising that this fund has performed strongly against its peers on a risk-adjusted basis since inception. In addition to its low fee and strong performance, what sets this fund apart from the other S&P 500 trackers is our positive view of Vanguard.

The source of Vanguard's competitive advantage and the foundation of its culture is its mutual ownership structure. Fund shareholders own Vanguard through their funds, which compels the firm to operate at cost rather than for profit, and to put investors' interests first.


iShares Core MSCI Japan IMI (IJPA)

The MSCI Japan IMI index, as tracked by this ETF, includes around 1,200 Japanese companies, including large, mid and small caps, which combined represent 99 per cent of the total Japanese equity market.

With an ongoing charge of just 0.2 per cent, the fund is one of the cheapest in the Morningstar category, which includes both active and passive funds.

The yawning fee gap between this fund and that charged by the average fund in the category (1.64 per cent) has proved to be a formidable hurdle for active managers. The fund has outshone its surviving category peers over three and five years on a risk-adjusted basis.

We also have a favourable view of the seasoned iShares passive management team, which is befitting of the dominant ETF provider in Europe. The team can leverage market-leading technology and a well-oiled securities lending programme while managing its funds.


Lyxor EuroMTS All-Maturity Investment Grade (DR) Ucits ETF (MTXX)

This physically replicated ETF tracks an index that spans the full spectrum of investment-grade eurozone government debt. The breadth of exposure, which covers both core and peripheral issuers, means the fund is suitable as a core building block within an investor's portfolio.

With an ongoing charge of just 0.165 per cent, the fund holds a considerable cost advantage over its actively managed peers in the euro-denominated government bond market.

Its low fee has helped propel the fund into the top quartile when ranked against its peers on a risk-adjusted basis over both short and multi-year periods.

Furthermore, no active peer has been awarded the Gold analyst rating. This clearly reflects the limited opportunities to add value over a standard benchmark in this particular market.


Kenneth Lamont is a European passive fund research analyst at Morningstar.

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