PARTNER INSIGHT: Since index funds were opened up to smaller investors in the 1990s, they have proved enduringly popular, with investors embracing the ability to track the market at relatively low cost.
As Head of Index for EMEA at LGIM, Colm O'Brien oversees the group's £330bn invested in index tracking strategies, and he is clear in his assessment of investing: "There are many different ways to run an index fund." LGIM has a term for its own favoured method: "pragmatic replication". What this means in practice, says O'Brien, is a common-sense approach to achieve efficient tracking at a low cost to investors. "We really try to exploit any index efficiencies, to add value for our clients," he explains.
While LGIM sets out to achieve something close to full replication for its index funds, what sets it apart is a willingness to hold back where market conditions don't allow it to buy or sell a share for a fair price. In those cases, LGIM uses a measure of sampling until liquidity improves. Individual weightings are allowed to fluctuate within a narrow band, consistent with each fund's target tracking error. This minimises unnecessary rebalancing - and the associated transaction costs.
For some of its funds in this range, the firm uses a more traditional sampling technique. This is mostly done in funds tracking bond indices, though it can also be used in equity funds too, depending on the features of the specific market. Whatever the fund, strict risk parameters control any deviation from the benchmark.
One of the most challenging events for index fund managers is the periodical rebalancing of the benchmark indices that the funds are designed to track. This often unleashes a frenzy of activity as many investors seek to buy and sell those securities on the same day, leading to price distortions.
LGIM has also developed a proprietary scoring tool to analyse the environmental, social and general business impact of fund companies and the group is looking to extend this successful approach with new offerings over the next year.
"We constantly look to evolve and bring new products to the marketplace. For our retail clients, we've recently launched a range of ICAV products, and we're looking to extend that significantly over the next six to 12 months," O'Brien promises.
"We've also seen a significant growth in factor-based investing - we believe we can bring relevant products to the UK retail market soon."
Click here to learn more about LGIM's targeted and pragmatic approach to managing index funds
