Magazine Issues » October 2013

ETFs: Congested channels

JunctionHeavy concentration of exchange-traded funds within Europe is predicted to remain. But, more positively, there is evidence of greater use by pension plans, though their uses are narrow, finds Nick Fitzpatrick.

Credit Suisse, fed up with trying to gain scale in its exchange-traded fund (ETF) business, sold it. The sale to BlackRock closed in July and involved $17.6 billion (€13.1 billion) of assets under management (AuM) across 58 funds.

However, $8.6 billion of this was in nine Swiss-listed funds, suggesting just $9 billion was split – thinly – across the rest.

ETFs can be expensive to run. Though they may be low in cost for investors, they usually require multiple listings on stock exchanges across Europe and this means the products can be a drain on resources for providers. Scale is highly sought after.

As a rule of thumb, Detlef Glow, head of research in Europe, Middle East and Africa at Lipper, says a fund needs €100 million to break even, though it depends on the index and how it is replicated.

Providers would no doubt take comfort reaching the €1 billion watermark, but Lipper research shows that there are not many of them in Europe which have.

Only 41 of the 1,743 ETFs in Europe hold assets above €1 billion and these 41 funds collectively account for 44.5% of Europe’s €263.57 billion ETF assets.

The high level of concentration is not expected to change soon, says Glow.

“The European ETF market is highly concentrated, and this pattern will not change in the foreseeable future. The AuM in the European ETF sector will continue to grow, but the growth rate will be lower than in the past, and the impact from market movements on the AuM will increase,” he says in a report.

Glow expects ETF providers to scale back their more unprofitable product ranges, and adds that there could be further takeovers – like BlackRock and Credit Suisse – or other events that could put promoters out of business.

Yet despite smaller inflows, product clearances by providers, and perhaps exits from the markets by some of them, Glow also anticipates ongoing ETF launches, particularly in fixed income, where there is less coverage by ETFs.

Fortunately for providers, though, there are signs that the source of inflows for them is diversifying.

For a start, Glows notes that ETF providers have been able to establish relationships with fund platforms, which offer another route to market.

It is the Retail Distribution Review in the UK that – as a consequence of its more specific aims of ending fund-selection bias – should make ETFs more available through adviser channels and platforms for the general public.

Other regulations, such as the Markets in Financial Instruments Directive II, should also extend this development to Europe.

Glow says that in addition to the cooperation between providers and retail platforms, “new regulations at different levels might become a driver for further change and growth in the industry”.

Maybe even more promising is that there is also separate research showing that ETFs have risen in importance for defined benefit (DB) pension plans and other investors in the aftermath of 2008, when the collapse of Lehman Brothers had triggered the financial crisis.

A study of investor allocations since 2009 shows that ETFs have gained a “notable prominence” with a 26% increase in the amount of DB investors who favour ETFs for short-term investment opportunities.
The finding is from a report by Create-Research, a consultancy, and sponsored by Principal Global Investors. The report, entitled Asset allocation, leaders, laggards and newcomers: 2009-2013, covers global investors, but is biased towards European investors.

Nearly 50% of DB plans used ETFs to gain exposure to emerging market bonds and equities, Create-Research finds.

However, for medium-term asset allocation, traditional index funds were favoured – not just over ETFs, but in asset allocation terms generally.

The report also covers defined contribution (DC) investors, retail and high-net-worth investors, where ETFs did similarly well.

ETFs boxDC investors preferred traditional index funds for medium-term allocation, with a 22% increase in those that demanded them since 2009. No score was given for ETFs.

But for opportunistic investing, ETFs registered a 25% increase.

ETFs led in the retail-investor category as the instrument with the biggest increase in demand from investors over medium-term asset allocation (28%) and for opportunistic investing (33%).

In the high-net-worth category ETFs came second to traditional index funds – 19% and 24%, respectively – for medium-term allocation, but led the field with 11% for short-term opportunities.

Professor Amin Rajan, chief executive of Create-Research, says: “The shift in investor focus from wants to needs is marked, as is the accompanying change in the underlying asset mix. This process has created its own leaders and laggards. It has also catapulted new asset classes to the fore, especially ETFs. The longer the debt crisis lasts, the more ingrained will these changes become.”

At Lipper, Glow adds: “In terms of new products available to investors in Europe, I expect that the number of funds will grow further, as not all market segments, especially the bond segment, are yet covered by ETFs.

“In my opinion, strategy ETFs will become more important, as a number of investors are looking for alternative index approaches, and could therefore become a key driver for the future growth of the industry.”

©2013 funds europe