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Nutmeg’s core approach to ETFs

The retail digital investment management firm Nutmeg utilises ETFs to create its portfolios. James McManus, (pictured) investment manager, who has specialised in ETFs throughout his career explains that the firm now manages just over GBP600 million across 25,000 clients who start at a minimum level of GBP500 and can have many millions with the firm.

“For us, it’s about not trying to reinvent the wheel in terms of asset allocation processes, but executing it as efficiently as possible,” McManus says. “One of the great advantages of launching Nutmeg was starting with a blank sheet of paper so we could build systems to maximise what we get out of ETF products.”
The vast majority of Nutmeg’s ETFs are traded with specialist marketmakers who are put through a somewhat brutal audition process designed to arrive at the best possible price for investors. Nutmeg uses a pool of over 15 marketmakers in total, inviting five or six appropriate specialists to pitch a price for their specialist security within five minutes.

They usually come up with a price within 20 seconds, McManus says, and they can then see where they are in the listing. The best price wins and the data from this process is registered so that Nutmeg can keep up with who is the best in which sector.

The firm estimates that this process has saved GBP1 million in one year in trading costs. Nutmeg achieved 4.9 per cent annualised performance between 30th September 2013 and 30th September 2016 on a medium risk portfolio.

Over his career, McManus has seen significant growth in ETFs and has few concerns about liquidity in the sector. “The core of ETFs is a basket of securities, so if you understand the securities’ liquidity and what it costs a marketmaker to hedge that basket you can understand the liquidity of the product,” he says. “We look at the second stage of how deep the market is.”

The range of ETFs in which Nutmeg manages money is pretty wide - last year they owned Indonesian equities through an ETF.

“Clearly you have to be more careful at the cost of trading those securities,” he says. “We spend a lot of time working on the liquidity side to make sure it’s scalable as we grow as a firm. Any product has to be suitable for the future, including the fast asset growth we expect to see.”
The volume of money flowing into the ETF sector increases liquidity, he says. “More and more institutional players are coming into ETFs, major hedge fund managers, asset and institutional managers.”

Core to the Nutmeg offering is to provide the same level of service whatever level of wealth the client has. The range of investment knowledge on behalf of the clients varies considerably from it being their first experience of investing, through to sophisticated investors. “All are looking for simplification and the peace of mind that there is an investment team monitoring and managing their investments,” McManus says.

A Nutmeg client sets his or her own risk level and money is managed in 10 risk buckets which are actively managed along the risk spectrum from very light to 100 per cent risk, or five fixed allocation portfolios that do not change.

Education on ETFs comes through blogs and interactivity through social media and a 15 person customer service team in the office ready to answer questions and chat. Recent outings for Nutmegonomics have focused on the costs of trading ETFs and how the firm keeps the costs down.

Nutmeg only invests in physical ETFs so uses none based on synthetics or swaps. “We want our clients to understand the underlying products in their portfolios. It’s not fair for a retail client to be expected to understand how the swap market works.”

A regular question is why does Nutmeg favour ETFs over index funds and McManus answers that there are multiple reasons but one of the most important is the flexibility that ETFs offer, in terms of the choice of assets, with over 1800 listed on the London Stock Exchange alone.

There is also a broader range of assets in ETFs than in index funds and then there is the flexibility and clarity in the way they can trade them. “With an index fund or mutual fund you buy at tomorrow’s price at noon whereas with ETFs we know the live price instantly.”

Nutmeg is not keen on the term smart beta, preferring to create ‘tilts’ in portfolios to reflect an underlying theme. “We have a tilt toward US large cap value stocks at the moment within our US equity exposure. Essentially we are using a halfway house approach, because the strategy we have selected remains market cap weighted whilst providing exposure to stocks with value attributes.”

McManus is increasingly frustrated with smart beta ETFs based on indices which are not easily understood by private investors. “It is increasingly difficult for retail investors on their own to have the resources to evaluate all the strategies. Alternative weighting schemes do require a lot of work to understand.”

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