CLIENT BASE: Mistaken identity

ETF providers often say their clients are ‘mostly institutional’. But what does this actually mean? Angele Spiteri Paris looks at customer classifications.

In the exchange-traded funds world, traditional client classifications take on new meanings. When one thinks of “institutional” clients, pension funds are the first investors that spring to mind. But although ETF clients in Europe are mainly institutional, one would be sorely mistaken to think that these client books are teeming with pension funds.

What can be classed as institutional money in ETFs actually refers to investments by fund managers themselves and wealth managers managing money on behalf of high net worth individuals.

As Farley Thomas, head of ETFs, at HSBC, says: “It’s difficult to use definitions from traditional asset management when talking about clients in ETFs.”

But anyone not closely linked to the ETF industry would not be aware of this. David Gardner, iShares head of sales Emea at BlackRock, says: “Within the ETF industry, it is well understood what the institutional tag means, but once you step out of the ETF world, there are definitely misunderstandings.”

Vin Bhattacharjee, head of Emea intermediary business at State Street Global Advisors (SSGA) says: “The word institutional is very overused in the ETF industry.”

Daniele Tohme Adet, head of ETFs and indexed funds development at BNP Paribas Asset Management, agrees: “What we call institutional is not the ‘real’ institutional classification we use in asset management. That’s because it’s mostly asset managers themselves who use these vehicles.”

Therefore, it stands to reason that there are some grey areas in the perception of who uses ETFs in Europe.

People from other parts of the asset management industry must, therefore, be aware that when it comes to ETFs, “everyone who is not a retail investor is an institutional client”, says Thorsten Michalik, head of db x-trackers.

Gardner calls them “professional investors” while Thomas splits ETF clients into three segments – the trading community, that is, the fund managers using ETFs instead of cash, for example, the wealth managers and fund of funds, and the retail market.

Thomas says one could classify the trading portion and the wealth management portion of assets under management in ETFs as institutional but overall “the institutional label for ETFs is not very useful”.

And the tag even causes confusion at the user level. “Even fund managers don’t understand that the term institutional in relation to ETFs is different from what they call institutional,” says Gardner.

Although there are no statistics for the European ETF market according to client type, Thomas says: “The greatest contributor to volumes in the market is the trading community [fund managers and hedge funds], while the wealth management clients form the largest portion of the assets under management.”

Gardner agrees: “The majority of the business, 60% to 80%, currently sits with investors such as fund managers and insurers.”
The picture is the same at BNP Paribas. Tohmé-Adet agrees: “In Europe, ETFs are widely used for asset allocation and the largest asset allocators are fund managers.”

Current and future
But the likelihood is that, going forward, wealth managers will plough substantial flows into ETFs. Gardner says: “The wealth market will be a large driver for growth.”

And Thomas agrees: “The wealth management contribution to ETF AuM will expand significantly. This space will be a big growth engine for ETFs in Europe.”

The reasoning behind this prediction is that the investing community is seeking greater levels of financial advice. And as a result, the wealth managers will make greater use of ETFs due to their convenience and cost-efficiency.

Gardner says: “The role of the advisor is going to become more important and, since a large portion of the investment market in Europe will be intermediated, we will see increased use of ETFs.”

Bhattacharjee says: “The intermediary segment is set to grow rapidly over the next two to three years.” According to SSGA’s client classifications, this sector includes any financial institution that invests on others’ behalf – therefore, any player that needs to raise money from third parties before they can make any investments.

Michalik says: “Private banks will be an increasingly important client segment for ETFs because many clients want a cost-efficient product that gives exposure to all markets.”

Michalik also explains that insurance companies could have a larger stake in the ETF AuM, particularly in certain countries. “In Germany, the rules were recently changed allowing insurance companies to hold up to 5% in commodities. Therefore, they will now be able to invest in ETF products that directly track commodities indices,” he says.

Dan Draper, global head of ETFs at Credit Suisse, agrees that insurance companies will also be a client segment of growing importance for ETF providers. “From an efficiency and resource perspective, it’s better for insurance companies to manage money on a top-down basis and make use of instruments like ETFs to implement their asset allocation decisions,” he says.

According to Draper, investors taking a top-down approach to investment are and will continue to be key clients. “Those institutions that are top-down asset allocators, such as traditional long-only fund of funds, are becoming more global and are moving very quickly into ETFs.”

Pension funds
There has been a lot of talk about pension funds using ETFs. At present, there is little evidence of widespread use by this client base. Yet the industry continues to trudge on and try and increase ETF penetration among pension funds.

But is this a battle in vain? Some think so.

“Real institutional investors, such as pensions funds, are not interested in ETFs,” says Tohmé-Adet. “For these clients, ETFs are not cheaper than traditional index funds institutional share classes or mandates.”

Due to their size, large pension funds can negotiate better deals on the fees they pay managers to run a segregated mandate offering passive exposure. Also, if they chose to invest via the traditional indexed fund route they would fall into the institutional share class, which commands a much lower fee than the retail share class.

Draper says: “Pension funds have not been large users of ETFs because they have cheaper access to long-term traditional index funds.”

However, Draper says: “Pension funds that have a tactical overlay are starting to use ETFs in their satellite portfolios.”

Gardner also says this type of usage on the rise. “The utilisation of ETFs on behalf of pension funds will increase for tactical exposure only.” He says it is still very early days and one cannot predict whether this will change anytime in the future.

Thomas adds: “Asset allocation models will have to change for pension funds to allocate to ETFs.”

Ultimately, one has to wonder, does it matter to ETF providers where their clients come from?

Bhattacharjee says: “It doesn’t really matter. Each client group has different characteristics so one needs to be aware of these.”

Michalik says: “It’s important to not depend on just one client base, but given the diversify and variety of ETFs, I believe there will
always be demand for them from one client segment or other.”

©2011 funds europe



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