... and although fund platforms should help ETF providers grow their business in the UK retail market, Nicholas Pratt finds there are still operational issues.
The UK’s Retail Distribution Review (RDR), which came into force in January and shakes up the independent financial advice sector, means investors should be able to see exactly how much they are paying advisers, and what for.
In a recent speech, Linda Woodall, the Financial Services Authority’s head of investments department, said the RDR should make sure that commissions or other forms of remuneration do not influence advisers’ decisions or the quality of advice they offer.
ETFs are commission-free products and, therefore, fit for purpose in a post-RDR world. Consequently, the new regulations are welcomed by ETF providers.
However, their exchange-based, passive products do not yet enjoy the same profile among retail investors in the UK as in the US.
The UK retail market is still heavily reliant on the independent financial adviser (IFA) community. More recently, fund platforms have become a central feature in the distribution process leading to the suggestion that the ETFs will have to increase their presence on platforms if they are to exploit the advantages that the RDR has created.
The RDR is nevertheless a game changer in the UK for ETFs, says Mark Johnson, head of iShares UK.
“More advisers will be looking across a broader range of vehicles, including ETFs. Part of this will be enabling IFAs to select ETFs via platforms, which are increasingly the method of choice for IFAs, so we want to ensure that we are on the platforms.”
He adds: “We are already on some and we are in discussion with many others. The biggest challenge is education; to ensure that customers and IFAs understand the need for ETFs, where they can be bought and the various ways they can be used as part of an investment strategy.”
Not all platforms host ETFs. “Cofunds does not offer ETFs,” says Verona Smith, director of marketing at the independent investment platform.
“However, the new pricing model has been developed in such a way to enable us to bring investment vehicles such as ETFs onto the platform. An exact date for this has yet to be confirmed.”
FundsNetwork, the platform owned by Fidelity, launched 50 physically backed ETFs from four providers (Credit Suisse, iShares, HSBC and ETFS) back in June 2012.
According to Klare Baldwin, head of marketing, it is still too early to tell how much impact the RDR will have.
“We are definitely seeing IFAs becoming more educated about ETFs, but whether this will translate into steady flows remains to be seen. The demand we have seen though, has been to use ETFs as part of a model portfolio rather than on a stand-alone basis.”
In theory, there should be no reason why, in a post-RDR environment, a commission-free ETF should not get equal shelf space on fund platforms with other passive funds and with active funds that have previously featured so prominently.
Nick Blake, head of retail UK at Vanguard, says that Vanguard’s commission-free mutual funds have managed to get on the more sophisticated platforms but have taken longer to be accepted by fund supermarkets.
It has been more challenging, however, getting ETFs on the same platforms. “The platforms tend to be more funds-based than securities-based and even the more sophisticated wrapped platforms struggle on the functional side,” says Blake.
As an example, he says some people buy ETFs for their intra-day trading capability which only works if they are capable of being traded in real-time rather than on an end-of-day batched basis, as with many mutual funds.
“Fund supermarkets that are in the process of complying with the RDR in terms of unbundling are still a long way from being able to support ETFs in a functional sense.”
Consequently, 2013 will be a year of transition for many of the UK platforms, says Eleanor Hope-Bell, head of UK intermediary business at State Street Global Advisors, as they adapt to the pricing rules from the RDR and the operational, or piping, issues involved with accepting ETFs. There is recognition from platforms that ETFs play very well in a post-RDR world and many of the platforms have done a good job in terms of meeting ETF providers and educating themselves.
But their biggest issue remains piping. “Platforms have been great aggregators and reporters, which suits traditional mutual funds, but it is very tricky to fit ETFs into that same infrastructure.”
Some platforms have realised this and have been quick to try and address the structural issues while others have opted for a temporary fix that enables them to cram ETFs into their existing structure.
“This is fine short-term, but I would question whether it is appropriate in the long term given that it would not allow investors to take advantage of the benefits of ETFs and having a share instead of a unit,” says Hope-Bell.
To try and solve the pricing issue FundsNetwork launched an unbundled pricing capability in 2012. In terms of the piping issue, the platform has adopted a funds-type approach to ETFs, running them as funds and pricing them on a once-a-day basis so that they are fully integrated with other funds on the platform.
The operational challenges facing traditional fund platforms have not gone unnoticed. Discretionary fund managers, wealth managers and stockbrokers that are familiar with securities-based investment products, such as ETFs, have developed their own platforms to compete with traditional platforms. Furthermore, these platforms offer IFAs a lower cost, says Blake, at Vanguard.
There will also be pressure on the platforms as well if they ignore ETFs, which have proven their worth as low-cost vehicles, he adds. “The platforms leave themselves open to investors going elsewhere. And for the platforms that do include ETFs, they will have to think about their pricing strategy.
“Unbundling means that they now have to separate the fees for investment management, for administration and for advice, and investors will wonder why they are paying fund administration prices for ETFs.”
The idea of ETFs fighting for shelf space on platforms alongside active funds and other passive funds may have some negative connotations, especially for platforms that have a pay-to-play policy. Some ETF providers are not willing to pay those charges, says Craig Phillips, principal at research firm CoreData.
“But I don’t think being on the platforms is a panacea for ETFs. The products still have to be good enough. If not, they could sit on the platforms and not get any interest.”
Phillips also believes that ETF providers will have to consider changes in portfolio construction in the post-RDR world. CoreData’s research shows that there has been a reduction in the use of single manager active funds and more growth in the model portfolio space, which is cheaper from an operational perspective.
“ETF providers should also be looking to work with the designers of these model portfolios to be considered in the design process. It is more about how they blend with other products and strategies as opposed to competing for shelf space on the platforms as stand-alone products.”
According to Hope-Bell, 2013 may well be seen as a turning point for ETFs but as part of a gradual evolution.
“This is not a binary issue. It is not a case of the floodgates opening and ETFs dominating the market. I think they will slowly start to make an impact if the platforms’ piping issues are overcome, [if] ETF providers are able to integrate their products into multi-asset investment products and new advisor models, and if investors continue to educate themselves on the benefits
©2013 funds europe