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Julia Khandoshko, Mind Money
Julia Khandoshko, Mind Money

Can we embrace modern portfolio construction with ETFs?


Julia Khandoshko, CEO at the European broker Mind Money, writes that in recent years, interest in ETFs has been at the highest level ever. According to statistics, inflows to active US ETFs exceeded previous records in both monthly and quarterly terms, above USD750 billion. Investors infused USD65.6 billion in active ETFs in the three months to the end of March—more than 50 percent higher than the previous record of USD41 billion in the fourth quarter of 2023.

Furthermore, ETFs occupy a dominant position in US model portfolios. The data shows that they make up 51 per cent of assets. Given the ETFs’ constant growth and strengthening positions, it’s worth having a closer look at the ETF’s potential.

Сhanging paradigm made ETFs come to the fore

With increasing digitalisation and the introduction of artificial intelligence technologies, the market is becoming more efficient, making it more difficult to find undervalued assets to invest in. Major funds have evolved into more powerful and technologically advanced entities, and competing with them in the market examination has become more challenging.

In this regard, diversification is becoming increasingly important. For example, we can buy Pepsi shares instead of buying only Coca-Cola shares. Furthermore, more advanced expertise for any investor has become much more necessary. The market has become huge and a multiple of what it was. And it is more challenging for investors to understand every process—30 years ago everything was much simpler. 

Besides, from the company’s side, it has also played a role whether you are part of the S&P 500 or not. Today, the market situation has changed completely—it is imperative whether you are part of an ETF or not. Now, if some stock is included in the index or the ETF, it means that this stock is already more expensive than precisely a similar company whose shares are not included in the index or the ETF.

Formerly, asset management companies appeared to “give away” their clients to the firms producing ETFs. Nonetheless, ETFs have since gained independence from their creators, making them increasingly appealing to fund allocators. Additionally, it’s important to note that ETF prices have decreased, further enhancing their attractiveness.

Strategies for how to use ETFs in clients’ portfolios

Previously, the recommendation to invest in ETFs from professional asset managers was considered with skepticism, as it seemed to undermine the value of their expertise. It raised the question of why asset managers exist if any investor can easily buy ETFs as a ready-made solution.Nevertheless, it’s crucial to recognize that having an ETF in a portfolio is not a radical step or a way to demonstrate your incompetence. Today, it is standard practice, and ETFs offer numerous advantages.

To be precise, it has become much easier for asset management companies to buy ETFs than short treasuries. As it is already assembled, ETFs on short treasuries imply a strategic shift towards efficiency and convenience. 

In the past, exposure to gold meant purchasing physical gold. However, the market has evolved, offering investors gold ETFs. They provide a convenient route for accessing the metal without needing physical possession. Gold ETFs facilitate direct participation in gold trading through fund investments. They are increasingly recognized as an excellent option for medium-term investment, particularly amidst the recent gold interest surge.

Before the 2008 crisis, conventional wisdom dictated that investing in emerging markets necessitated direct investment in those markets. Now, in 2024, no one recommends you build a portfolio of the Latin American oil industry by buying its shares. Instead, the contemporary approach uses emerging markets ETFs, offering less risky and more diversified exposure to these regions.

Do not forget about regulatory challenges and tax implications

The strength of the U.S. industry is that it typically channels all purchases through the U.S. However, today, some fragmentation can be tracked that becomes an impediment to this paradigm—European regulations scrutinise individual American ETFs that lack a European prospectus. 

Additionally, as new types of ETFs appear in the US, such as those for cryptocurrencies, the legislation in other countries struggles to keep pace. Consequently, when you invest in US ETFs, tax implications in your home country become a hurdle, leading to several complications. For example, European investors may face a severe tax policy when buying ETFs. As a result, European investors may seek professional advice to optimise their investment strategies in light of this complexity.

Future of ETFs

Unfortunately, the legislation problem may only get worse in the future. To prevent the USA’s complete dominance in the market and remain competitive, European and Asian countries will likely need to introduce supplementary tax measures for consumers. 

Despite that, the future of ETFs looks promising due to constant innovation to meet investors’ evolving needs. 

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