"Wealth Management Still Dominated By Commission-Driven Funds"

Paul Amery is the managing editor of IndexUniverse.eu, specialising in financial and economic themes.He worked in financial markets for 20 years, as a fund manager, bond trader and product manager, as well as spending two years as an advisor to the government of Ukraine in the mid-1990s. In this exclusive interview for MyPrivatebanking.com Paul talks about the specific aspects of ETF and index investments from the point of view of indiviudal, private investors.

MyPrivateBanking.com: Do you think that ETFs and index products have now also made a breakthrough in the wealth management for private individuals?

Paul Amery: No, I wouldn't say that. I think the European wealth management industry is still dominated by commission-driven fund products, particularly funds of funds, mutual funds and structured products such as capital-guaranteed bonds. I don't want to suggest that all of these products are bad, but they typically involve costs which are many multiples of those in index funds or ETFs. I'm pretty sure that index funds and ETFs will grow substantially in the future as a share of individuals' portfolios in Europe, but this will happen slowly, by a process of osmosis, as people learn of their benefits.

MyPrivateBanking.com: Which are the most important rules a private investor should give his wealth manager for ETF/index investments?

Paul Amery: First: Set a suitable asset allocation. Easier said than done, as this is more art than science, but ask yourself two questions when working this out: how much can I afford to lose from each investment, and am I sufficiently diversified?

Second: Save using a regular savings plan, if possible, to smooth out market fluctuations.

Third: Examine all the possible alternatives for portfolio construction, whether this means using style or sector ETFs - don't just stick with country funds because they are the best known.

Fourth: Review the index types used and make sure you're comfortable with them.

Fifth: Work out your portfolio's costs, not just on an annual basis, but including the cost of trading if you are likely to rebalance frequently.

Sixth: Make sure you're using the most tax-efficient vehicles.

MyPrivateBanking.com: Are there any specific risks associated with ETFs a private investor must watch?

Paul Amery: Generally speaking, as funds ETFs are relatively a safer option if the sponsoring bank gets into trouble than a lot of other savings products, where you are an unsecured creditor of the bank. However swap-based ETFs do carry modest counterparty risk to the swap provider (usually the parent bank of the ETF issuer - up to 10% of the fund's asset value under European regulations), and ETFs that use physical replication may have risks associated with securities lending policies. These risks have to be put into context of the larger risks associated with investing, but it's a good idea to find out how the ETF you're using replicates its index. Certain types of index replication strategy - for example in leveraged ETFs, and ETFs tracking indices which can suffer a negative "roll yield" (for example in credit and commodities) can also cause unexpected price effects, so be aware of how these work if you're considering using them. Other tracker products - ETCs, ETNs, for example - are bonds, not funds, although they may have collateral backing. These need to be examined individually.

MyPrivateBanking.com: In which cases should one refrain from using ETFs or index products?

Paul Amery: I think ETFs and index products are suitable for the vast majority of savings portfolios. They've even appeared in quite unexpected places. Money market ETFs, for example, are now widely used as an alternative to bank deposits because of the fund structure and the associated collateral backing. If I had to pick one area where I'd advise investors to be careful it's in leveraged funds, as these are quite unsuitable as long-term investments.

MyPrivateBanking.com: Paul, thanks a lot for this interview!