The notorious bankers at Royal Bank of Scotland plugged a big hole recently in the asset allocation choices for passive investors by launching a UK small cap index tracker.1 However my street party was short-lived, as the fluffily-named RBS HGSC Tracker (ticker: RS64) comes with bigger buts than England’s front-row.

Small cap companies have historically trounced the FTSE All-Share2 over the last 50-odd years. Research suggests investors are paid a ‘small cap premium’ for taking a punt on riskier pygmy equities.

Unfortunately the small cap punt is riskier still when it comes in the shape of RBS’s UK small cap index tracker – it’s neither a cuddly index fund nor a comfy old Exchange Traded Fund (ETF).

RBS call it a Redeemable Certificate, and that raises all kinds of questions.

Let’s try to answer a few.

What’s a certificate?

Even though you’re buying the return on a clutch of small cap equities, a certificate doesn’t invest directly in the shares it tracks. It’s effectively debt issued by the bank. In exchange for your money, RBS promises to pay the value of the index tracked, plus dividends.

The debt is unsecured, meaning that if RBS3 goes bust then you’ll probably get buttons. Your investment isn’t backed by a nice cushion of collateral.

That 100% exposure to the credit-worthiness of the certificate issuer is the main drawback of this kind of tracker.

Certificates are an obscure offshoot of covered warrants, are all the rage in Europe, and are the near-identical twins of Exchange Traded Notes (ETNs) that are popular in the US. But I digress.

Other key features of the certificate are:

• The RBS HGSC tracker trades on the London Stock Exchange (LSE).
• You buy and sell it through a broker, just like an ETF.
• The main advantage of a certificate is it does away with tracking error.
• It returns the value of the index minus the annual management fee.
• Dividends aren’t paid out as income but are rolled up into the certificate.

What’s the index?

The RBS UK small cap tracker follows the RBS HGSC (Tradable) TR Index, a cut-down version of the venerable Hoare Govett Smaller Companies index.

• It comprises up to 200 of the smallest 10% of companies listed on the LSE.

• It’s filtered to only include firms that traded an average of £10,000 worth of shares every day over 3 months.

• A company’s weight in the index is capped at 5% to ensure diversity of holdings.

• Weightings are reset once per year.

• TR stands for total return; it means that dividends are assumed to be reinvested in the index.

The FTSE SmallCap index represents the bottom 2% of the UK’s weeniest listed companies. So the full HGSC index (which contains over 400 companies excluding Investment Trusts) would normally bite off a fair chunk of the bottom half of the FTSE 250 as well. Knocking out 50% of the most illiquid tiddlers will heighten that FTSE 250 exposure even more.

But it’s nigh on impossible for retail investors to take a view on that because RBS doesn’t publish details of the index holdings on its website – a miserable failing in comparison to ETF issuers like iShares and db X-trackers.

That alone makes my investing antennae twitch with distress. Understanding the index you’re tracking is a key part of passive investing.

You can at least get an idea of the sector weightings of the full HGSC index courtesy of fund manager Aberforth.

What are the costs?

The annual management charge is 0.6%. Certificates don’t speak in terms of Total Expense Ratio (TER) because they don’t comply to UCITS fund regulations. Again, we’re straying off the garden path and into a darker neck of the woods.

Still, 0.6% AMC is reasonable and compares with:

• 0.85% Aberforth Smaller Companies Trust (Investment Trust)
• 0.58% CS ETF (IE) on MSCI UK Small Cap (ETF)
• 0.27% FTSE 250 Index Retail Acc (Index fund)

On top of that, you’ll pay a spread to buy and sell. The bid-offer spread is 1%, under normal circumstances, according to RBS.

That is steep and is equivalent to paying a load fee for every transaction.

You’ll pay the usual broker’s commission, too.

The HGSC Tracker is supposedly available through all the major brokers. You may need to give them a phone call though because it’s confounding many of the broker search engines I tried, even some of the ‘preferred partners’ RBS lists on its own website.

Try looking in the broker’s covered warrants section if all else fails.

Funny stuff

The certificate has an expiry date. Like most other types of debt it eventually matures and that pay back date is April 19th, 2021.

Come the day, RBS will pay out whatever the index is worth after 10 years, plus dividends. If the index is on its knees then there’s no waiting out the storm, unless you can reinvest in an identical tracker at the time (presumably paying out more on commission and the spread).

You’ll also notice on the HGSC Tracker’s website a number marked ‘effective gearing’. Happily this doesn’t mean you’re exposed to some hideous amount of leverage. It refers to the proportion of the index value that one certificate share represents. If you multiplied the price of one share by the effective gearing ratio then you would get the value of the index.

RBS say you can hold their small cap tracker in an ISA or a SIPP as long as you buy more than five years before its expiry date, but Hargreaves Lansdown, for one, say it’s SIPP only.

While the factsheet cautions you to read the prospectus, RBS have mysteriously failed to put it on their own website – what reason can there possibly be for that in this era of digital communication? Apparently, we’re welcome to pop into their offices to pick up a copy, or it’s available online via the LSE. Good luck finding it. Please tell me if you do.

RBS owns the index the certificate is tracking. That’s a potential conflict of interest brought home when you read this choice piece of small print:

The Index rules may be amended modified or adjusted from time to time by RBS as applicable. Any such amendment may be made without the consent of or notice to investors in instruments linked to the Index and may have an adverse effect on the level of the Index.

Now I’m used to reading things in prospectuses that seem anything from a bit rum to the work of gangsters, but then my usual range of investment vehicles have run for decades without calamity so I might be prepared to give them the benefit of the doubt.

The same can’t be said for certificates. It also turns out that RBS can redeem the certificates early if:

…the closing price of the Index cannot be determined on a particular day due to a suspension or limitation of trading or other disruption to trading or early closure of the London Stock Exchange or any other exchange.

Certifiable?

Taking all this together I can’t say I’m a fan of the RBS HGSC Tracker. Aside from the credit risk (and in truth it seems unlikely that RBS would really be allowed to pop) and the painful bid-offer spread, it’s the lack of transparency that puts me off.

Certificates can be used to provide low-cost access to otherwise hard-to-reach markets, but the only reason you’d choose this particular UK small cap index tracker is because of the sheer lack of alternatives.

Take it steady,

The Accumulator

1. CUKS, the Credit Suisse UK Small Cap ETF is a closet FTSE 250 tracker in my view. [↩]
2. The Hoare Govett Smaller Companies index has outperformed the All-Share by 3.4% per year since 1955 according to a report by Professors Dimson and Marsh, who devised the HGSC index. [↩]
3. That’s RBS the semi-nationalised UK banking behemoth, severely wounded during the credit crunch and saved by the Government. [↩]

Some musings, then the weekly reading links.

I am a sucker for academic papers on happiness and money, and whether watching The Apprentice every Wednesday can do much for either.

True, I’m not sure they’re of much practical use. I’ve got a hangover this morning, making me question exactly where I’m going with my life, and making me feel rotten. It’s severely skewing my personal data set.

On a society-wide level, however, they do provide an interesting challenge to the direction that markets and mainstream capitalism is taking us – which let’s face it is determined more by the invisible hand making come hither gestures than by any 20th Century-style grand plan.

Don’t worry, be a believer in an expensive dress

In their recent paper Happiness, Meaning of Life, and Income, Lois Duff and Artjoms Ivlevs of the University of the West of England pitted these three variables against each other in a cockfight:

The paper explores the non-material determinants of happiness. We go beyond the well-established result that individual ‘religiousness’ is positively correlated with happiness and look at a broader spiritual activity – time spent thinking about the meaning and purpose of life (MPL).

We […] find that the educated, the religious, females and the middle aged are more likely to spend time thinking about the MPL.

The correlation between happiness and thinking about the MPL depends on a country’s income: it is negative in high income countries and positive in low income countries.

You can download the whole paper via the link above, but here’s my summary: If you want to be happy, then be a well-off female in a poor country and believe in God, or if not spend a lot of time wondering whether you should.

Alas, that’s a lifestyle change that few of us can make. And anyway, if you’re a middle-aged man in the UK who believes in evolution (I do) and has decided to bow down before Richard Dawkin instead (I definitely don’t) then a sex-change and a relocation to Burkina Faso isn’t going to cut it.

You can’t forget where you came from because you can’t forget what it taught you.

[continue reading…]

Young corporate go-getters are often amazed at the attitude of their more jaded peers.

They find some people who’ve been ‘enjoying’ the grind for a decade or more feel entitled to goof around to make the day more bearable.

Early in my wage-earning life I met one of them, a pleasant middle-aged bloke – let’s call him Graham – who told me he adopted a ‘two-for-one’ principle. For every two hours he worked, he took one hour off.

Graham explained that the company sucked up so much of his week, and was run so poorly and inefficiently, that he had to strike back for the sake of fairness.

What about the workers?

Graham hadn’t got a raise or promotion in years, and he moaned about that, too. But what really mattered to me was Graham and I worked on the same projects!

Being young and keen, I wanted to get my stuff done, impress the right people, and push on. By either delaying our projects or forcing me to cover for him, Graham was wasting my time, as well as his and the company’s.

Parkinson’s Law says that ‘Work expands so as to fill the time available for its completion’. It was coined in the 1950s in an Economist essay.

Despite this, I liked Graham a lot – he was helpful, friendly, funny, and even wise in an office otherwise populated by Aspergic alien body snatchers. As I got older, though, I became fed up with his sort of attitude – and others who felt entitled to a sick day every three weeks, and malcontents who’d actually sabotage projects as a misguided blow for workers’ rights.

I wasn’t especially bothered by the impact on my employer’s margins of their actions, even if I myself felt (and still do feel) a moral duty to do a day’s work for a day’s wages. I was never a fan of the rat race – I just wanted to work on interesting stuff – and I already suspected that Graham was correct that management buffoonery was at least as wasteful as his own scheduled mini-breaks.

No, what got me was I felt taken advantage of by my own peers. I became sick of covering for people who’d skip work with a mild headache (perhaps brought on by the sunny weather) or those whose lunch meetings always ran until 4pm (perhaps because of the wine…) A couple of years in work stripped away any lingering leftist sentiment held over from my student days.

Older and even more cynical, I now see this work ethical peer pressure is part of what makes a modern company tick in place of the rigid strictures of yesteryear. I felt a rebel, but I was allied with The Man…

…almost, but not entirely. When I saw a chink of light, I ran for it, went freelance, and used techniques such as the 80/20 rule and Eating The Frog to double my productivity and income, while dumping stress like a balloonist ditching ballast.

The Pareto Principle, also known as the 80/20 rule, can change your life. In summary: A few big clients make you most of your money. Your greatest skill is your key earner. Most of your time should be spent doing a few important things. And so on. You’re either in the 20% who try it and live by it, or you’re one of the 80% who’ll never get it.

Nailed it

Completing a day’s profitable work by lunchtime once you’ve escaped from the Kafkaesque drag of office life is a heady feeling. But of course the natural order of things strives to out.

After a few months of spectacular efficiency, Graham re-entered my life – only this time he was the flipside of my conscientious Protestant personality.

Compared to wayward freelancers I’ve known (with vices ranging from Australian soap operas and a gardening fetish to life-threatening substance abuse), my own version of Graham was a home office nuisance as opposed to an agent provocateur.

Looking back, I wish I’d taken a few more of the summer afternoon walks he touted. But mainly he encouraged me to waste countless hours on the newly-fangled Internet. Still, this was when I deepened my interest in investing my own money, and though it now took until 2pm to get that day’s work done, in the long run it was time well wasted.

Moreover, I was wasting time on my terms, and could immediately see any impact on my own finances. The Heath Robinson pipeline of cause and effect of the modern office is stripped when you’re freelance to a hammer and a nail.

Hit insufficient nails with your hammer – or hit them screwy – and you don’t get paid. No blaming another department’s poor tools. Nobody cares.

Poacher poached

I immediately loved being a freelance and I’d recommend it to anyone.

Yet as I write – and this is the grand reveal of this post – I’ve actually been in a full-time job since the start of this year.

Given how much I’ve maligned office life during my four years of blogging, I knew I’d have to come clean eventually.

The good news is I’m not about to recant. My employer is genuinely one of the good ones, but sometimes I still feel like a Native American rounded up and penned in to whittle wooden wigwams on a reservation.

The time wasted on the traditional office routine can be extraordinary. My old routine of getting up when I naturally woke up (invariably between eight-thirty and nine) and slotting breakfast, showering, a spot of lunch, and maybe a bit of laundry into screen breaks – has been replaced by the archetypal soul-crushing London commute that puffs out a near-7-to-7 working day and leaves you scrabbling to squeeze in domestic life at the edges.1

“I work all day and get half-drunk at night,” said Philip Larkin. Too right – except he didn’t have to suffer the London Underground to get back to his favourite pub.

A fair cop out

Why then am I doing a job? Because I’m field-testing corporate life and rechecking my prejudices just for you – my dear readers.

Okay, not really. The truth is at a certain point last year my hitherto Teutonic efficiency turned into Old Bloc bungling. And as is the freelance way, I immediately saw it in my bank balance.

There were a lot of factors involved in this farrago, most of which are very personal, nothing to do with money or work, and not something we can generalise into a ten-year itch of the self-employed.

Put simply, I looked about and realised if I didn’t get a bucket of cold water in the face, I could soon be graduating from daytime TV and lolling about in the garden to something far more… unproductive.

The Office

So I got a job somewhere interesting, to push skills I haven’t previously tested enough, in an area that interests me.

And it’s been… okay.

Most of what frustrated me before about full-time employment before can still be frustrating, while like the lead character in Douglas Coupland’s Girlfriend in a Coma I’ve also stepped into a new world of grief.

For example, when I was last in full-time employment, mobile phones, email and remote working systems were all still a novelty. As a freelance I used them all to the hilt, and didn’t mind the way they mixed up work and post-work – but it feels more of an imposition coming from an employer.

But to be honest, I now see it’s not them, it’s me. I suspect if full-time office life annoys you, then it will always annoy you, whatever your urgent motivations for returning to the workforce.

For others, a secure place of work is a comfort. Most of my colleagues seem pretty satisfied with a day’s pay in exchange for the routine and rigmarole. They don’t appear to share my fear that I’m tossing away precious time like sending glinting 50 pence pieces tumbling into a dark and deep well.

Even old Graham knew his place. For all his griping about the waste of corporate activity, office politics that make Labour Party scheming look like a chinwag between Ghandi and Mother Teresa, and about the bizarre doublethink that sees nobody at work saying what they mean and even fewer doing what they say – for all that, Graham was a corporate creature. He was finely tuned to work’s ecosystem, and to its 47-week seasons. He’d starve outside of it.

Me, I’m from the high plains. I’ve come down to the city seeking work, weapons, and perhaps a few tattoos.

But one day I’ll go home.

1. To be clear, I mean I wake and start preparing to go to the office about 7, and I eventually get home around 7, too. I do not work all 12 hours in an office. I am not mad. [↩]