Wealthy Swiss investors aim to increase their usage of ETFs, even at the expense of hedge funds, finds Mark Vallon of Source, who analyses data from 20 wealth management firms.
The rise of exchange-traded funds (ETFs) has been one of the strongest stories in asset management in recent years. Their increasing appeal to investors is illustrated by figures from industry consultancy ETFGI that show assets held within ETFs and other exchange-traded products (ETPs) in Europe rose 10% from $458 billion (€415 billion) to $506 billion over the course of 2015, with the number of products rising from 2,089 to 2,188 and providers from 49 to 51.
To better understand how ETFs are being used by investors and why, Source commissioned a qualitative survey among wealth advisers in one of Europe’s most prominent asset management nations, Switzerland.
No analysis of how ETFs are used in Switzerland could begin without reference to its rapidly changing regulatory landscape.
The Swiss financial industry is being fundamentally changed by new rules being introduced by the regulator, Finma. These have raised the regulatory bar to match the standards set by the European Union’s Alternative Investment Fund Managers Directive and Markets in Financial Instruments Directive, and require a major step up in compliance capacity for many of the country’s 2,000-plus independent asset managers.
The new regulations are applicable to asset managers and distributors, and impose more onerous capital requirements and substantially higher compliance hurdles that demand strict new organisational and staffing requirements.
Source’s research involved interviewing 20 wealth/investment managers at private banks, wealth management firms and some family investment companies, all serving private or institutional clients and personally managing more than the equivalent of €65 million. All were specialists in investments and key decision-makers in actively selecting investments and executing decisions for clients, many of whom are domiciled around the world and require a 24/7 service.
One of the implications of the regulatory changes has been the disappearance of ‘retrocession’ fees. Similar developments have been seen in other countries such as the UK, where ETFs have also seen an increase in popularity.
There was still some uncertainty among respondents about the impact of the new regulations, but they did all agree that compliance requirements would increase time spent on administration: One respondent said: “There is a lot of administration and reporting. Part of it is research into investments.”
Another said: “There is a lot of reporting required by clients, which is crucial. Client contact is increasing as more clients are more informed by financial media, visit offices and participate in decisions.”
All of the respondents were using ETFs. Usage of ETPs overall ranged from 10% to 50% or more of the assets they managed. They often had direct relationships with account managers at ETF providers and used platforms and provider websites to research products.
A lot of respondents said that because of the broad range of exposures achievable through ETFs, they would use them to diversify and balance a portfolio, especially for clients who were more cautious and liked to broaden their risks. The lower charges meant that they could also use ETFs to keep costs down.
ETFs that track the main indexes such as the S&P 500 were popular with advisers in Switzerland. This is because they did not require extensive research to be understood and they were also well known to clients.
All of the respondents in the survey had increased their usage of ETFs over the past year. Reasons given for this were that actively managed funds had not performed and awareness of ETFs’ virtues had grown, especially with regards to lower costs versus other products. They also expected to increase their usage even more at the expense of hedge and fixed income funds.
So, what are the advantages and disadvantages of using ETFs, according to the survey respondents?
Features highlighted as positives included ETFs’ propensity to offer tailor-made opportunities, even in niche markets; high liquidity, transparency, cost efficiency and ease of use.
For example, some of the respondents variously said that “ETFs are low cost and you get exposure to very specific niche markets”; “The variety has increased, as has the awareness in clients. You can efficiently invest in markets that you might not have before”; “They have reduced the effort for research. You don’t always have to go into detail. It also gives you the possibilities of focusing on specialisms.”
One theme that came across strongly in the research was that brand was a key consideration for investment advisers in Switzerland. It was highlighted how they felt it was essential to buy ETFs from a well-known provider because this inspired confidence and made it easier to sell to clients who knew the brand too.
However, we also found limited awareness among our respondents of the ETF provider universe. Most preferred to work with a few preferred brands that were overwhelmingly established and well known.
In conclusion, our research holds several lessons for ETF providers trying to carve out a place in an intensely competitive market. Key criteria in selecting ETFs for many of our respondents were low tracking error, broad coverage of asset classes, liquidity, low cost, and products they regarded as “solid, trusted and real”, with a marked preference for physical ETFs over synthetic.
Innovation was also key: as much as our respondents admitted to a limited understanding of ‘smart beta’, it was a space that they would like to see more solutions from product providers.
Key issues for respondents were brand, service and innovation.
Raising brand awareness is crucial to building a customer base and any new product provider will have much to demonstrate to non-users.
The service given by product providers should also include good intelligence, especially regarding products providing exposure to non-traditional, exotic markets.
This is a requirement resulting from the imposition of higher compliance standards, but also a world of volatile markets that have engendered much uncertainty about where future returns will be derived.
Mark Vallon is an executive director at Source
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