In an interview recently conducted with IndexUniverse.eu, Aldous described his firm's business approach as a pioneer in ETF-only investment management, before sharing his current market views.

IU.eu: Christopher, your company is known for only using ETFs in its client portfolios - could you explain why you've chosen this route?

Aldous: We are unusual in that we've never used anything but ETFs. So we don't come with any of the baggage usually associated with active managers - we've always advocated indexation. We're not wedded to ETFs as the magical solution - it just so happens that they are cheaper, safer, more transparent and easier to use than other forms of indexation  We regularly review other indexing solutions to compare them to ETFs in terms of cost and tracking error, for example.

I'd add that we see our mission as trying to add value through asset allocation, rather than through stock picking, so ETFs are the natural instrument for us to use.  The range of asset classes available has also improved dramatically. Three years ago, for example, we wouldn't have been able to get access to listed private equity, listed global property, water, forestry. Anything that the Yale Endowment can invest in, with the possible exception of hedge funds, we can do via ETFs.

IU.eu: Do you take short, as well as long positions?

Aldous: No - our default hedge is cash. We don't invest in an asset class unless we expect it to beat cash on a tactical and strategic basis, and this year we've done well by having high cash balances. 

IU.eu: There has been a lot of debate this year about the relative merits of physical and swap-based replication of indices by ETFs.  What are your views on the matter?

Aldous: It comes back to the "easier, safer" comment I made earlier. We feel most comfortable using ETFs that employ full replication, since there is no structural or counterparty risk. Having said that, we're happy with synthetic replication, but we do have risk guidelines that limit the amount we can hold in any portfolio in any particular structure. Like most ETFs, synthetically-replicated funds tend to be part of an umbrella structure, where there is always the risk of cross-contamination, even though theoretically funds are protected cells.  One has to be aware of that. But we're broadly happy with the risks involved, as UCITS III guidelines limit swap counterparty exposure to 10% of NAV. Bear in mind though that there is also an asset mismatch risk in swap-based ETFs, in addition to the counterparty risk. All these factors give us a certain amount of concern, and we try to have as much as we can in fully-replicated ETFs as we can without compromising our asset allocation views.  We don't like structured products - we prefer very simple access to asset classes. And for the same reasons of concerns about counterparty risk we haven't used ETNs or ETCs, though I'm not saying there's anything wrong with them, and we are comfortable with the new, collateralised ETCs on offer.

IU.eu: How is your asset base split by client type, and how much do you have under management?

Aldous: We have roughly a third each represented by charities, family offices and high net-worth private clients, though we're now actively pursuing the pensions market as well. We've only been going a year, and have around £100 million under management, though we very much expect to have doubled this, at least, by this time next year.

IU.eu: How do you structure your fees, on top of the ETF fees?

Aldous: We regard the ETF fee as the tracking error.  Of course we disclose the [underlying ETFs'] total expense ratios, but these are not so relevant if the use of stock lending or dividend optimisation reduces the tracking error to a few basis points. Incidentally, this is another great thing about the ETF market, in that it is competitive, and fund issuers do have an incentive to compete to bring costs down, track indices more closely, and reduce inherent risks - they're unlike many other investments, in this sense. On top of that we apply a sliding fee scale, based on funds under management. For a £3-5 million private client we often find we can shave at least 0.5% per annum off the fees they'd typically be paying by investing in a range of actively managed funds - this compounds to 5.1% over ten years.

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