ETF experts reflect on the growth of the industry, its main challenges, and the key trends to watch out for in 2021.
Michael Horan, Head of trading, EMEA, BNY Mellon Pershing
The current trading environment is one of the most complicated backdrops the buy-side community has had to deal with in its history. Heightened volatility, increasing regulatory obligations and the need to follow, understand and trade a diverse range of products and asset classes on behalf of clients is adding huge pressure on firms even before factoring in the uncertain Covid-19 economic backdrop.
Alongside the increased utilisation of outsourced trading support, the rise of ETFs is helping alleviate this pressure for the buy-side. With the rise of passive investment strategies, coupled with the benefits of the lower fees they attract, client order flow is more focused at a fund level and less in multiple direct investments, with clients able to gain exposure to a certain segment by sending one ETF order to a trading desk, rather than ten or 20 stocks with the same exposure profile.
When it comes to market structure, this growth in the ETF market is tightening spreads and, as a result, there are a wealth of liquidity providers in the UK and Europe providing sized orders on a multitude of MTFs [multilateral trading facilities]. Exchanges have seen volumes ramp up, driven by a mass of smaller clip sizes, and retail investors are starting to make a considerable dent in market share.
As we look ahead, it is possible that mutual fund providers will be further challenged by the growth in the ETF market as we start to see some in the US turn their funds into active non-transparent ETFs. Whether this trend is here to stay or not remains to be seen.
A QUESTION OF EDUCATION
Caroline Baron, Head of ETF distribution EMEA, Franklin Templeton
The ETF industry has demonstrated significant resilience during the Covid crisis which has recently led to greater investor interest. To further help take the ETF industry to the next level, there are some areas which need to be improved, i.e. infrastructure when it comes to ETF execution. Many platforms around Europe are still not catering for ETF execution and when they do, costs are high, and the service does not always meet expectations. Once we have progress on this front, we might see a new wave of investors embracing ETFs.
Education is still going to play a key role on both retail and institutional fronts: providing investors with information which outlines the merits that ETFs can bring to a portfolio in terms of reducing costs, transparency, and ways to better manage risks is important. Also, informing investors how liquidity works for ETFs will help to break some of the legacy myths. As we see an increasing number of investors shifting to outcomes and solutions, ETFs will be able to play an important role in helping meet these outcomes.
Regulators, industry associations and the media have a role to play to highlight the benefits that ETFs bring to the industry and to foster a more level playing field with other vehicles.
The ETF industry has been on the front foot with ESG by issuing many new solutions to help investors transition their assets into what they believe is sustainable companies and sectors. This shift towards ESG may be an accelerator of ETF adoption.
Last but not least, we are still in a retrocession-driven world for some of the countries around Europe and when that goes, ETFs will be able to be discussed more prominently around Europe. Until then, we have to count on the relentless efforts of ETF providers to enhance the knowledge of the new and existing users and to keep bringing innovative strategies to help meet end investors’ expectations.
THE FUTURE OF PASSIVE FIXED INCOME
Michael John Lytle, Chief executive officer, Tabula Investment Management
In the last three decades, equity investing has been transformed by passive indexing. Once the value of passive core positions was established by Fama, French, Samuelson and Bogle, the path to execution was not very complicated for equities. The underlying securities trade on exchange with intraday prices and closing auctions. Companies generally only have one class of equity securities outstanding. Market capitalisation means something concrete as it lines up with revenue, earnings and book value. Equity indices have been watched and used by investors for over a century. Dow Jones Industrial Average was established in 1882, S&P 500 in 1957, MSCI in 1969 and the Nasdaq in 1971. By comparison, the Lehman Aggregate Bond Index, which traces its origins to 1973, did not start ticking until 1986 and was bought by Barclays in 2008 and then Bloomberg in 2016. In fact, a raft of M&A in fixed income indices in the last five years shows that the space is just starting to come of age.
Not surprisingly, today 20-30% of equity assets are managed passively while the number is around 5% for fixed income. Fixed income is poised for a quick catch up and the potential scale is breathtaking. The fixed income asset class is twice the size of equities (US$100 trillion vs US$50 trillion). But there are challenges to indexing fixed income. The asset class is highly heterogeneous. There are over 9 million securities to consider and both data and trading activity are patchy. The path to transformation is not linear but it will be eventful, exciting and deeply beneficial to investors.