July 7, 2015
|By Consulting Group|
Tracker funds and passively managed ETFs are generally considered to be the cheapest and most effective way to gain exposure to the stock market. If only seeking access to UK equities, this is probably just about the case – with a Fidelity UK index tracker costing 0.09% a year, or £5.85 on a £6,500 investment.
However, for those wanting a bit more diversification, what’s the best way to invest in, for example, the NASDAQ index? The iShares NASDAQ ETF charges 33 basis points per year, equivalent to £21.45 per year, plus trade costs. However, NASDAQ 100 Futures trade with CFD (contract for difference) providers such as City Index and IG at a 4 point spread. An investor can purchase a future at £1.50 a point with a 6 month expiry date, and pay a roll cost of half the spread every 6 months, meaning total charges of just £6 a year, with the cost of trading effectively £3 to purchase and £3 to sell.
With such low costs, it’s somewhat surprising that CFDs maintain a reputation as a tool for speculators not to be touched by cautious investors. However, there is a chance that this will change following the entrance into the market of companies such as InvestYourWay and Bux. Both of these use CFDs to provide low cost, flexible trading and investing, but without the leverage that characterises most CFD providers.
The services they offer differ slightly:
InvestYourWay produces tailored diversified funds according to timescale and desired risk profile, using CFDs in indices and ETFs from across Europe, Asia and North America. Investors can then adapt those funds further, by adding exposure to specific sectors or commodities. For this tailored service, investors pay a 1% annual management fee.
Bux is different, targeted at this time more towards traders than investors, but like InvestYourWay using the low-cost trading afforded by CFDs to offer a very low minimum investment along with restricted levels of leverage.
So will low or non-leveraged CFDs provide the route catalyst to encourage new and inexperienced investors to access the stock market at ultra low-cost? Hopefully, but there are significant barriers to overcome first.
- Regulation – At present, CFDs are regulated as complex products under MiFID, even though a client’s exposure is no different whether they own a FTSE 100 tracker fund or a non-leveraged FTSE 100 CFD. This means providers need to ensure the product is appropriate for its clients, hampering the user experience and increasing the information that the provider must collect and store.
- Intangible – There is no physical instrument for the client to hold. This has two impacts. First, this means that beyond the £50,000 of assets covered by the Financial Services Compensation Scheme, investors are completely reliant on the provider to pay them the returns they earn – their investment is not transferable.
InvestYourWay and Bux have tried to mitigate this by using much more established operators, IG and Ayondo respectively, to provide the CFDs. However, it might prove to be a barrier to persuading people to invest more than £50,000. It might also prove an important psychological barrier for inexperienced investors. Many people, including my wife, are put off investing because they don’t understand how it works. When I asked this ‘focus-group of one’, she said that whilst she would be reluctant to invest in a share or a fund, the fact that you were physically buying a product was somewhat reassuring, and a CFD offers none of that reassurance.
The use of non-leveraged CFDs clearly has huge potential, and personally I think InvestYourWay and Bux are great products. However, that alone won’t make them successful, and they have a long way to go if a critical mass of investors will embrace them as the way to invest for the future.