Press Releases

Global – December 9, 2009 - The vast majority of Exchange Trade Funds (ETFs) are an unattractive long-term investment option for most institutional investors according to Watson Wyatt, a leading global consultant. The firm says that while the development of the sector has driven a great deal of product innovation, institutional investors should consider ETFs in conjunction with alternative options because ETFs generally have higher fees than many institutional index products; may have tax implications that require specialist advice; and often contain counterparty risks which investors may not be compensated for. The firm also suggests that there is a great deal of development within indexation, which is likely to offer passive investors a broader range of options and better risk-adjusted returns than those currently available. 

Chris Sutton, senior investment consultant, said: “The Exchange Traded Funds business is to be applauded for its substantial innovation and the way it has opened up a world of potentially interesting market exposures. However the case for their inclusion in institutional investment portfolios is not yet obvious as we wait to see more competitive fees and transparent structures. In the meantime, they may be useful tools for transition and shorter-term exposure management. Where the ETF industry has engaged in product proliferation, we would rather press for genuine innovation in the investment content of index products. If investors are looking for more efficient market exposures their first step should be to review the indices underlying their existing investments, with a view to seeing if there are better alternatives.”

According to the firm there are a good range of institutional passive products available in most markets, which are cheaper than many ETFs. In addition, in many markets, passive funds have been structured with clearly defined tax positions for institutional investors, while the treatment of ETFs is much more variable, which typically necessitates tax advice.

Chris Sutton said: “ETF sponsors have also embedded significant amounts of counterparty risk inside ETFs, whether through stock lending or the way in which swaps are used. It is not clear that investors are being adequately compensated for having to take these risks when holding an ETF.”

The firm suggests that ETFs can be useful tools for transition and exposure management but asserts that most investment strategies can also be implemented more cheaply and efficiently using index funds, index futures or swaps.

Chris Sutton said; “While there is a lot of noise around the profusion of ETFs now available in the marketplace, the real story is investors’ realisation that capitalisation-weighted portfolios are not necessarily optimal, leading them to contemplate shifting significant assets into alternative weighting approaches.”

Notes to editors
Alternative index weighting approaches include:

• Equal weights are a way of reshuffling security weights, with each security getting the same allocation. Tiered equal weights are a variation on this theme.
• Fundamental Index® weights¹ which seek to address the return drag associated with market capitalisation indices caused by the link between a stock’s price and its weight in the index.
• Risk weighted portfolios may create more optimal portfolios by combining relatively uncorrelated stocks
• Factor tilts can pick up a premium from long-term biases to certain areas of the market.

¹ Fundamental Index® and several variants of the term are registered copyrights of Research Affiliates, LLC. We are using the term with their permission.

For further information please contact:
Paul Deane-Williams
Head of Public Relations - Investment and Insurance & Financial Services
Watson Wyatt Limited
+44 (0)1737 274397
paul.deane-williams@watsonwyatt.com

Visit Watson Wyatt's online press office:
www.watsonwyatt.com/europe/news/journalists

About Watson Wyatt Investment Consulting
Watson Wyatt Investment Consulting, a division of Watson Wyatt, is focused on creating financial value for institutional investors through independent, best-in-class investment advice. We are specialist investment professionals who provide co-ordinated investment strategy advice based on expertise in risk assessment, strategic asset allocation, and investment manager selection. Watson Wyatt Investment Consulting provides investment advice to some of the world’s largest pension funds and institutional investors, and has over 570 associates in Europe, the Americas and Asia.

In the US investment advisory and investment consulting services are provided by Watson Wyatt Investment Consulting, Inc., which is a subsidiary of Watson Wyatt Worldwide Inc. Watson Wyatt Investment Consulting, Inc., is a registered investment adviser with the Securities and Exchange Commission.

Watson Wyatt (NYSE, NASDAQ: WW) is the trusted business partner to the world’s leading organisations on people and financial issues. The firm’s global services include: managing the cost and effectiveness of employee benefit programs; developing attraction, retention and reward strategies; advising pension plan sponsors and other institutions on optimal investment strategies; providing strategic and financial advice to insurance and financial services companies; and delivering related technology, outsourcing and data services. Watson Wyatt has 7,500 associates in 33 countries and is located on the Web at www.watsonwyatt.com.