The significant benefits of ETFs have caused a surge in their popularity in recent years. HAHN harnesses the power of these vehicles to build a better managed portfolio for investors combining all of the benefits of ETFs with global tactical asset allocation expertise.
Through index ETFs, investors receive diversified exposure to all of the securities comprising that index with a single transaction. An ETF designed to track the S&P 500, for example, provides exposure to 500 of the largest companies in the United States (by market capitalization) from the first dollar invested.
The recent proliferation of ETFs means it is now possible to obtain diversified exposure to virtually any geographic region, market sector or asset class in the world – a benefit previously only available to large, institutional investors.
Numerous studies have shown that proper asset allocation, as opposed to individual security selection or market timing is the largest determinant of the variability of portfolio performance. With this in mind, HAHN spends its time on the decisions that matter: top down global asset allocation and best of breed ETF selection, performed within a controlled risk management framework.
Using passive ETFs to build portfolio, HAHN achieves far greater diversification than would be possible through the use of individual securities.
Based on the fundamental view that passive index investing and active portfolio management are not mutually exclusive, HAHN incorporates the best of both; the active management of passive indexes to deliver better returns with less risk.
ETFs are among the most liquid investment vehicles available today. Being listed on a stock exchange means they can be bought and sold throughout the day, much like a stock. ETF liquidity is further facilitated by market makers – (large investment dealers whose job it is to create or redeem units in response to supply and demand to ensure a liquid market). Ultimately, the liquidity of an ETF reflects the liquidity of the securities in the underlying basket.
Liquidity makes ETFs the ideal building blocks for globally diversified, actively managed portfolios. By using ETFs to implement portfolio strategy, HAHN can rebalance or tactically re-position the portfolio much more quickly and cost effectively than with individual securities.
The composition and weights of the underlying securities in an index ETF are public knowledge and disclosed throughout the trading day. Investors can determine, therefore, what securities they are invested in, which is not always the case with other managed investments such as pooled funds or mutual funds.
Transparency also enables HAHN to add value by carefully analyzing and selecting the best representative ETF available globally from each category, a “best of breed” approach. HAHN employs a rigorous and disciplined set of criteria in selecting ETF holdings which includes each ETFs diversification potential, tracking error, construction, strategy mapping, expenses, liquidity, and unique characteristics. With the rapid proliferation of ETFs in recent years, all new global ETF offerings are also reviewed for their eligibility in HAHN portfolios.
ETFs generally have low expense ratios, making them attractive investment vehicles for both retail and institutional investors. For retail investors, ETFs have become an attractive alternative to mutual funds.
For portfolio managers, ETFs provide a cost effective means of obtaining exposure to markets or asset classes that were previously prohibitively expensive to access. This enables HAHN to build a better diversified portfolio and to make active management decisions more cost effectively than with individual securities.
The higher tax efficiency of ETFs primarily is due to lower capital gains distributions. The “in-kind creation and redemption” process described above is a structural advantage that ETFs have over mutual funds, which allows ETFs to dramatically reduce the annually capital gains distributions to shareholders.
Although somewhat complicated to explain, it boils down to the way investors buy and sell ETFs as compared to mutual funds. Mutual fund investors deal directly with the fund company, which is required to distribute any capital gains generated annually as securities are bought and sold inside the fund to create and redeem mutual fund units. The “in-kind creation and redemption” structure of ETFs eliminates capital gains of this nature.
Index ETFs do generate taxable capital gains when the underlying securities are rebalanced, but turnover of this nature is generally low and the resulting capital gains are typically minimal.
Two other points to be aware of:
- The annual calculation of capital gains and losses based on the difference between the adjusted cost-base and the disposition price is the same for all securities, including; mutual funds, ETFs, stocks, bonds etc.)
- ETFs that hold bonds that pay interest, or stocks that pay dividends will distribute this income to unitholders the same way a mutual fund does and the tax treatment is the same.
Bottom line: tax efficiency makes ETFs attractive to individual investors and portfolio managers wishing to use them as portfolio building blocks while keeping taxes as low as possible.