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Weekend reading: Financial (ill) advisers shun ETFs

Money articles

My regular Saturday comment followed by this week’s blog and financial site links.

Ever wondered why people are bad with money? Turn to today’s Financial Times, which reports that most financial advisers have never recommended a low-cost ETF:

Just under two-thirds of independent financial advisers (IFAs) have never advised on ETFs, while 23 per cent have recommended the products to less than 10 per cent of their clients, according to research carried out by the Financial Times and Skandia, the investment group.

What a disgrace. These people are supposedly professionals, paid by their clients for advice on the best investing products, and almost two-thirds of them have shunned one that delivers cheaply and efficiently.

Let’s run through the facts again:

  • Most active funds under perform the stock market over time
  • Passive index-tracking ETFs deliver close to the market return
  • Active funds usually charge 1-2%
  • UK ETFs usually charge 0.25%-0.5%
  • Active funds pay advisers trail commission
  • An ETF does not give an adviser commission

Take a wild guess why advisers have not been recommending ETFs?

In the past year alone, only 43% of fund managers active in the UK market beat the FTSE 100. Come back in five years and that figure will be less than 30%.

It’s exactly the same in the U.S., where ETF providers like Vanguard have made more inroads into revealing the myth of active fund management.

These stats from Business Week make the case yet again:

During the five-year market cycle from 2004 to 2008, the S&P 500 outperformed 72% of actively managed large-cap funds, the S&P MidCap 400 outperformed 76% of mid-cap funds, and the S&P SmallCap 600 outperformed 86% of small-cap funds.

These results are similar to the five-year cycle from 1999 to 2003, according to Standard & Poor’s Index Services. […]

S&P’s benchmark indices also beat a majority of actively managed fixed-income funds in all categories during the five-year horizon. […]

To put it simply, active funds failed to beat major indexes in every fund category.

People often argue that you should not believe what you read on the Internet, but in this case my article on why passive index investing makes sense is actually free comment that’s better than what you’ll pay for from two-thirds of financial advisers.

There’s really no excuse. I could understand if two-thirds of advisers had recommended one or two active funds – despite the evidence that most under-perform – as part of a core-and-satellite approach to investing.

In other words, they might have had their clients allocate say 75% of their money into a simple, diversified ETF-based portfolio, and then add a few active funds or even stock picks to provide a little excitement and potential outperformance.

The chances are such a strategy wouldn’t outperform, but I’m realistic. I myself trade stocks and investment trusts and even indulge in a bit of market timing, despite knowing the odds are against me. Equally, I can see why an adviser might want to add a bit of flair to a client’s portfolio.

So while you could still be appalled at a statistic that two-thirds of advisers had recommended an active fund – and received a fee for it – alongside an ETF or index fund core, there might be a counter-argument.

But this is the opposite! And there’s absolutely no justification for nearly two-thirds of advisers never having recommended an ETF at all – to anyone.

People trusted these guys as the experts and have been let down. It’s like going to a doctor and being recommended a CD of whale songs and a bundle of sticks to hang from your bedroom door instead of a heart bypass.

Roll on 2013, when taking commission for offering advice will be banned.

From this week’s personal finance blogs

  • What would you be willing to do for a million dollars? – Len Penzo
  • Dove: The clean past and dirty present – Weakonomics

Other interesting financial and money articles

  • Advisers fail consumers on ETFs – FT
  • Life is not a box of chocolates (John Lee) – FT
  • The rise and fall of MySpace – FT
  • Recollections of China’s first capitalist – The Times

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{ 9 comments… add one }
  • 1 Rob Bennett December 5, 2009, 9:46 pm

    People trusted these guys as the experts and have been let down.

    I think this is true to a greater extent than you realize, Investor.

    My view is that our knowledge of how stock investing works is primitive. So everybody (I include myself in “everybody”) should make an effort to lower the arrogance meter a few notches. The trouble is, the less we know, the more uncomfortable we are with acknowledging it. We act certain because we lack confidence in our beliefs.

    It’s a mess!

    But perhaps good things will come of it, you know? You read lots of stories on blogs about people who messed up their finances so bad that they finally got serious about money and from that point forward became great savers. Perhaps we are going through something like that as a nation. Perhaps we are today living through the car crash stage so that tomorrow we can get to the “Drunk No More!” stage.


  • 2 Len Penzo December 6, 2009, 12:45 am

    Well said, Investor. Despite all the evidence, it boggles the mind how most financial advisers still manage to stay gainfully employed.

    And thanks for the mention too!

    Len Penzo dot Com

  • 3 KillianDark December 22, 2009, 1:58 am


    You must not have read the article — the author is espousing Passive Investing, and saying that the “Stock Selling Industry” ignores Index ETFs for the reason that they make no money off of them. Which is true.

    Yet, you are the man who has decided to declare war on passive investing and who also claims the “Stock Selling Industry” is making a fortune off of Passive Investing, somehow.

    So, how does that square with the article you commented on?

  • 4 Rob Bennett December 22, 2009, 12:58 pm

    Yet, you are the man who has decided to declare war on passive investing and who also claims the “Stock Selling Industry” is making a fortune off of Passive Investing, somehow. So, how does that square with the article you commented on?

    You’re asking a delicate but important question, Killian.

    Elvis Costello had a line in the song “New Lace Sleeves” in which he argued that:

    You say that the teacher never taught you anything but white lies.
    But you’ve never even seen the lies that you believed.

    Buy-and-Holders all the time attack non-Buy-and-Hold strategies as “financial porn.” But how often do they look at the investing strategy in the mirror?

    A week or two ago I referred to Buy-and-Hold as a “Get Rich Quick” scheme at another blog and a fellow commented that he never heard it described that way before. That’s the entire problem. Too many of us have treated this one approach as if it is above the financial influences that have corrupted so many other approaches.

    Yes, the promoters of other strategies often steer us wrong because there is so much money to be made doing so. The Buy-and-Holders are right to warn us about this possibility. There are wrong to think that those who promote Buy-and-Hold are not subject to the same financial pressures. Humans are humans no matter what the name of the investing strategy they have elected to promote.


  • 5 The Investor December 26, 2009, 11:14 am

    I think there are two issues to this debate (which as I’ve said before I’d rather not have too often on this blog).

    One is passive investing in a basket of equities as opposed to active fund management — ETFs versus a mutual fund say.

    The other is passive investment in the market, oblivious to conditions and averaging in over the long-term, versus making a timing decision (or decisions) based on some metric of valuations.

    To that effect, you could be a market timer who uses ETFs to trade in and out.

    I definitely agree with Killian that it’s hard to see a big money making machine at the heart of the ETF business, especially the simpler ‘vanilla’ ones, on which you need to be a Vanguard sized company to make decent profits on the tiny margins. Perhaps some of the obscurer ETFs with higher charges might be more suspect, but that’s another matter.

  • 6 Daddy Paul January 5, 2010, 3:14 am

    The only real pitfall I see with ETF’s for the investor is the desire to trade to often.

  • 7 The Investor January 5, 2010, 9:41 am

    @Daddy – Yep, that is a risk… another potential pitfall is in the more ‘exotic’ ETFs that providers charge higher fees for – possibly even approaching the fees of a managed fund. Leveraged ETFs are fairly dodgy in my book, and then there’s also debate over the profusion of sector-specific or themed ETFs (from clean energy to Sharia based ETFs) that some pundits argue takes away from the simplicity of ETF investing, though I personally think they’re a useful addition to the armoury provided the fees stay low and transparent.

    None of this takes anything away from cheap, core index tracking ETFs, however — provided investors aren’t confused into buying the others…

  • 8 timetotrade March 2, 2010, 9:06 pm

    Another consideration is that many advisers in the UK are “Appointed Representatives” of networks and the networks themselves can actually lay down restrictions on the investments the advisers are able to recommend. I don’t know if they have changed their rules recently, but certainly the largest IFA network in the UK simply did not allow their advisers to advise or recommend ETFs – even if the adviser had wanted.

  • 9 Thomas Jones April 5, 2010, 6:54 pm


    Many platforms – used by advisers – do not offer ETFs. In addition, a client that has a Stakeholder Pension or Personal Pension would NEVER be able to invest in an ETF as they’re simply not an option.

    If advisers used the ETF argument and started transfering pensions into SIPPs to gain access to ETFs the FSA would certainly have an issue with it as some clients simply aren’t sophisticated investors and therefore a SIPP wouldn’t be appropriate.

    As “timetotrade” pointed out, some of the large Networks research teams control what can be invetsed in. Advisers would at the very least need to seek special permission to sell an ETF. This is to ensure safety – not to disadvantage someone.

    Finally, many advisers will not sell something they don’t fully understand. More education is needed on ETFs and how they fit in with OEICs/UTs and how to risk rate them. Would you want an IFA to recommend a product they didn’t fully understand? look what happended with Arch Cru! Yet some advisers did sell their products and didn’t understand what they were getting involved with. Structured products is another example where some advisers did not fully understand the risks.

    There are companies that can pay commission from the amount invested e.g. Skandia. I’m not sure the commission argument is as strong a reason as it may appear.

    In reality ETFs will become heavily sold, after RDR, as the charges are a lot lower. An IFA taking 0.5% trail + initial fund charge would still be cheaper than most OEICs/UTs.

    Part of the fault is that ETF providers haven’t made a great deal of effort to enagage IFAs and Insurance companies – who still dominate the industry – aren’t about to support them when their in-house funds are where they make a nice living.


    Best Wishes,


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