September 2008

ETFs: Old Favourites

With a plethora of flavours available, Angele Spiteri Paris questions whether demand really exists for the ever expanding variety of ETFs Just as pink or brown can never really be the new black, no trendy exchange-traded funds (ETFs) that invest in arcane asset classes are likely to replace straightforward equity products. At least this is what certain providers believe.

It is worth taking note of too, because the effort to innovate in the ETF world has been extraordinary lately. But some providers know that products must remain in line with market demand.

“Our more vanilla products, such as the Euro Corporate Fund and the S&P 500 Fund are the largest in terms of assets,” says Suzanne Williams, senior product development manager at iShares. “These are the basic building blocks people are allocating to and I think that will always be the case.”

The key to success for providers in the ETF market is simplicity. “You have to make sure your products are easy to understand,” says Manooj Mistry, head of equity ETF structuring at Deutsche Bank’s db x-trackers. “Otherwise people may decide they don’t understand them and question whether they should buy them.”

Records and saturation
One fine day in August saw a record number of ETFs (19) being listed on the London Stock Exchange.

Although the European market is nowhere near saturation, the possibility of this happening in the future is very real given the amount of product roll-out lately.

Hector McNeil, head of sales and marketing at ETF Securities, says: “If every bank had its own brand of ETFs resulting in about 20 different Eurostoxx products, one would have to wonder whether that is healthy for the market.” He says that although there could be numerous ETFs concentrated in one sector, only a few would dominate. According to McNeil, a degree of market saturation has already happened in the US resulting in the closure of certain ETFs.

One of the risks of moving into uncharted territory in the ETF space is a possible lack of demand. Much has been said about the rise of active and inverse ETFs, yet some suggest that it may all end in tears.

Williams at iShares says: “We consider innovation in products that would service client demand. There are some products, like some of the active portfolios, which came out with a lot of talk about innovation, but the assets gathered have not been substantial.”

James Oates, head of marketing for SPA ETF, notes the launch of the ‘Sindex’ by FocusShares several months ago, which invests in ‘sinful’ stocks such as tobacco and gaming. Oates expresses doubts about its success. “Once you start making thematic plays on a micro level, I wonder whether the demand will exist.”

According to Mistry at db x-trackers, “Sometimes you know there is immediate demand for a certain product, but at other times you can launch a product with the mindset of looking to future demand.”

In fact, to a certain extent, the success, or lack thereof, of these new instruments could very well depend on the timing of the launch. A product that might not reap success today could be wildly popular in a few months’ or a years’ time.

Innovation in the vanilla space
Innovation does not necessarily mean moving into new strategies or alternative asset classes – it can simply mean expanding the product range available to allow for broader use of the ETF vehicle.

Just like adding sprinkles on an ice-cream cone, one can look to the ETF market for investment tools that could add a bit of sparkle.

Williams, at iShares, forecasts growth in fixed-income ETFs. “This asset class works well in an ETF format because it would be difficult for our clients to trade the underlying themselves,” she adds.

However, not all ventures away from the norm are doomed. ETF Securities has reaped success with its ETFS Short Crude Oil (SOIL) which became the most liquid product on the London Stock Exchange’s ETF/ETC segment and was the most highly traded on the LSE in August.

Buoyed by this triumph, McNeil believes one of the branches of future growth in the ETF space lies in shorting and leverage.

Scratching the surface
Although ETFs have been enjoying the limelight, the market in Europe is still very small and young. Currently ETFs make up less than 2% of European assets.
These vehicles are still a long way away from taking over from traditional passive fund management.

Yves Choueifaty, head of quantitative asset management at Lehman Brothers, is sceptical about some of the marketed benefits of ETFs.

He says he is not convinced they really do offer investors the cheapest deal. “When you buy an ETF, you have to pay for a bid/ask price as well as a custodian fee, which is often forgotten,” he says.

He adds that the custodian fee for an ETF is more often more expensive than that for a traditional passive fund. This suggests there are some hidden costs within the sector that sometimes go unmentioned.

So it seems, then, professional advisers are less interested in eye-catching new products and more concerned with the basic ‘nuts and bolts’. ©  2008 funds europe

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