Share page with AddThis

Supplements » ETFs Report 2011

ROUNDTABLE: Intelligent tracking comes of age (part 1)

The popularity of ETFs is booming and providers are having to supply unique and clever products to cope with demand. Some industry experts give their opinion on what investors should look out for.


Bernard Aybran (deputy CEO, Invesco)
Pedro Fernandes (head of ETPs, NYSE Euronext)
Frederic Lorenzini (head of research for Morningstar, France)
Tony O’Brien (head of ETF sales Emea, BNY Mellon Asset Servicing)
Denis Panel (CIO of Theam, BNP Paribas IP)

Funds Europe: The ETF market has continued to develop to meet industry demands. What new products have you seen coming onboard?

Pedro Fernandes, head of European exchange traded products, NYSE Euronext: There have been several new developments. For example, [in May] Lyxor launched an ETF on the Cac Mid 60, which is a French equity asset class that was not previously covered by ETFs. As ETFs on mid-size German and UK equities have been reasonably successful in gathering interest from investors over the last few years, it is expected that this new product on the Cac Mid 60 will meet existing investor demand.

Denis Panel, CIO of Theam, BNP Paribas Investment Partners: In terms of new products, we can see new asset classes: for example, volatility. There are also initiatives around currencies, mainly in ETPs [exchange-trade products] in general. In the equity space, we can see new types of indices emerging, and this is probably a trend that we need to monitor because I believe that investors now are looking for more non-cap weighted indices. Recent initiatives in this field will probably continue to grow over the coming months and years. So, the idea is that market cap-weighted indices are not efficient which is why we have to think about a new type of index. It’s true that through the ETF we need to be very simple and very transparent so it won’t be possible to address all the differences in non-cap weighted approach with an ETF, but it will definitely be a trend to monitor.

Fredric Lorenzini, head of research for Morningstar, France: We have seen the same trends in the European market – a lot of new products on small or mid-cap indices, such as the Cac or the Dax in Germany, and currency hedged shares. We have also seen what we call enhanced indices and we think this will be a big trend. There were definitely some drawbacks with classical cap-weighted indices, so enhanced indexing will address some of those shortcomings. Among the products in that domain, one should notice the two equal-weight ETFs recently launched by Think Capital, more to come with Ossiam.

We also expect to see more active ETFs to come to market. This will particularly be useful in some areas, such as fixed-income, where there’s a kind of premium to debt. In market cap indices, the more an issuer has debts, the more it is represented in the index.

There’s another interesting trend we have seen: the appeal for emerging market debt in local currencies. After equities, investors and promoters are embracing this asset class. What is really new is the fact that so-called ‘weak currencies’ are no longer seen simply as a risk but also as an opportunity. State Street has recently listed the first European ETF that tracks local currency emerging-market bonds: the SPDR Barclays Capital Emerging Market Local Bond ETF.

Fernandes: I do think we are seeing people moving from passive exposure towards a more active approach. Investors know how ETFs on the Cac and so forth work so now they’re looking for additional benefits of these products through active exposure. We are currently in a phase of transition; enhanced indices and more intelligent ways of building these indices are a clear example of this trend.

Tony O’Brien, head of ETF sales Emea, BNY Mellon Asset Servicing: Active ETFs are absolutely a trend for new products. Also Fredric mentioned currency hedged share classes, which I find very interesting, as across our European client base we’re seeing more and more interest in these. It’s my belief that the industry is trying to figure out the investor’s attitude towards the embedded currency risk within a particular index. So if you have a global index with maybe currency risk within it, would it be useful to offer a share class which hedges that currency risk as well as a share class that includes it? Sometimes investors want to take that risk.

The other thing of note is the advent of commodities products. This has been a trend for the past couple of years, starting with ETF Securities who really blazed a trail in the commodity space. Now iShares and Deutsche Bank have launched their own. Since some of these products need to physically hold the underlying commodities, they were structured as special purpose vehicles and not as Ucits. We’ve been happy to help clients build such vehicles.

The other interesting trend I’m seeing is providers using an ETF as a wrapper and putting it across an asset class that is not a traditional equity or bond asset class. For example, we’re seeing ETFs based on hedge fund strategies coming to market from some of the largest providers. It’s interesting to see how different providers of those products deal with the embedded structural issues, as a hedge fund strategy is usually designed for alpha generation and is limited in its liquidity. To try and reconcile that with an ETF product, which is structurally designed to be very liquid and to deliver transparent exposure to an underlying index or asset class, is a very interesting construct. Our people at BNY Mellon get tremendously excited about issues like that, because they love to roll up their sleeves and get into solving the technical details.

Also, over the coming years, ETFs in Europe will become more available to a retail client base. Traditionally, retail investors haven’t had access to hedge fund strategies or commodities so it will be interesting to see what issues arise as we sell those products to this client base.

Bernard Aybran, deputy CEO, Invesco: Many intelligent things have appeared on the ETF market over the past twelve months: new asset classes, commodities, currencies, and so on. But in some cases, the border between ETFs and other exchange-traded products has become blurry for us fund managers. This is quite uncomfortable for us investors because you never know whether you’re authorised or not to invest in a particular vehicle. What came as a little bit of a surprise to me was that a lot of the ‘not so intelligent’ developments that popped up, meaning new players launching funds on the same index, marketed the price as a new thing. There was war on prices, with some ETFs even priced at zero. So I would be very interested to know how many indices are tracked as compared to the number of ETFs or ETCs.

Fernandes: I can provide some figures on that. Right now, we have 550 listed ETFs covering around 360 indices.

O’Brien: For example, look at the multitude of products tracking the Dow Jones Euro Stoxx 50 Index. There is a huge number of these ‘me too’ products out there.

Fernandes: It is also important to note that distribution models and the different tax regimes and regulations create an environment where multiple products serve demand from different investors groups.

O’Brien: That has fractured liquidity as well. You have different levels of liquidity in different markets depending on where you’re trading. The interesting thing is that over the past three years we’ve seen the growth of providers who, although they are bringing largely the same products to the market, they’re not cannibalising existing products. Rather, they’re bringing new money into the ETF market. Some of these large ETF providers who are relatively new, such as db x-trackers and Credit Suisse, are tapping new distribution channels. It would, therefore, seem that bringing a new ETF based on the same index doesn’t necessarily dilute the available investment pool.

Should Europe move to a more retail-based distribution model, which is what happened in the US around the mid to late 1990s, it will be interesting to see how many of those products consolidate or disappear. With a product like an ETF where the TER [total expense ratio] is very low already, there’s limited scope for competition based on price.

Funds Europe: Which products registered the highest inflows over the past six months? And what were the drivers of this?

Panel: We can definitely say that the commodities ETF has had the highest inflows in terms of assets under management. In terms of drivers, we can see that investors definitely want to benefit from the dynamic of the commodities market; that’s the first obvious reason. The second is that now investors, especially institutional investors, use them for the tactical part of their portfolio. For the time being, they don’t use ETFs for their strategic asset allocation, but having them use these products for their tactical bets is a first step. In view of this, another driver for the growth in the commodities markets is the turmoil in North Africa and the Middle East. People want to benefit from this dynamic and so get exposure to these markets in a tactical way.

If we analyse our inflows in the equities space we see two ETFs posting strong inflows; the Cac 40 and the real estate Epra ETF because people want to diversify their investments.

Lorenzini: I collected some figures for the first four months of the year and they show that a large part of the €11bn of net new assets went into equity ETFs. Interestingly, almost €5bn of those flows went into single-country ETFs, especially Germany. According to our analysis, investors are starting to be cautious about where they want to put money in Europe. For example, they would rather invest in a safe place like Germany and they are definitely less interested in pan-European vehicles.

Money going into commodities is another trend, with €2.5bn in inflows for the first four months. This represents growth of almost 10% for the asset class. We also saw money going out of fixed income products – $1.5bn over the year to date. Most of the money flowed out of government bond ETFs.

In terms of firms, the largest collector of assets was iShares, followed by UBS, then Source and Amundi.

Aybran: I have a follow-up question for Fredric. Past performance is usually a main driver of inflows and outflows into regular funds, that is, people buy what has done well in terms of returns. Is it the same when it comes to ETFs?

Lorenzini: To a certain extent, yes, we see the same trends. The investor’s psychology is globally the same for ETFs as for regular open-end funds.

Aybran: So if they’re trend following, how come you haven’t seen the largest inflows posted in corporate bond ETFs?

Lorenzini: Regarding fixed income, the main driver is that people no longer want to put their money into govvies [government bonds] and they’ll take anything that isn’t govvies, for example. The general feeling is, ‘I prefer to invest in emerging market bonds ETFs than in Eurozone govvie ETFs’.

O’Brien: It’s interesting that when you look at inflows into ETFs over any particular period of time, there is a very close correlation to the general economic environment and to the markets themselves. So in Europe, ETF inflows can be a useful barometer of investor sentiment. For example, we saw strong growth in commodities ETFs in the first quarter and that correlates closely with the rise in commodities prices.

Fernandes: The positive data on inflows show that ETFs are meeting investor demand. The existing product offering covers a wide range of asset classes and strategies providing to investors transparent, flexible and liquid investment opportunities in different market conditions.

Lorenzini: Yes, but your assessment may lead us to another discussion regarding the fact that with the proliferation of ETF products we have the proliferation of indices, and some of those indices are being created from nothing and do not represent any market. So one drawback of the ETF market [and of it responding to client demand] is that you can have promoters trying to push strange products based on strange indices and we are starting to see more and more curiosities in the ETF field.

Funds Europe: Some providers have been making forays into active ETFs, with iShares gaining regulatory approval in the United States and Eaton Vance also getting the go-ahead from the SEC [US Securities and Exchange Commodities]. Do you see this taking off or is an active ETF a contradiction in terms? Will we see any providers attempt to bring active ETFs into Europe?

O’Brien: It seems as though we’ve talked about active ETFs for years; ever since we launched the first quasi-active ETFs in the US, around 2000/2001. When a provider comes to market with an active ETF, it is immediately taking itself out of the sphere of purely providing exposure to an index and is placing itself in the realm of providing alpha and performance to investors. This means that you need a performance track record, which takes time to develop. It’s very difficult to develop a performance track record for an ETF because in my view an ETF needs to gather a certain amount of momentum and a certain amount of liquidity before it can have any appeal to investors. This is almost a contradiction in terms and somewhat of a vicious circle – people are less likely to buy your active ETF because it has no performance track record; it is difficult to generate a performance record without scale and liquidity.

In the US, there are some providers that are going to be successful and some that are not. They have adopted numerous models from a structural point of view.

One of the traditional issues with an active ETF is finding a manager who doesn’t mind showing his portfolio to the market. But there are many ways of shielding that portfolio. For example, we’re dealing with some clients who trade intraday. Since they trade very quickly, the way they trade is not apparent to the market. We have some ETFs that are multi-managed so they have several different managers on the same portfolio and that also confuses the trading, and the portfolio that is made public. It’s going to be interesting to see how that develops. I think it will be a lot easier in the fixed income space because that is a bit more managed.

Lorenzini: We see active ETFs as a very interesting development in the industry for many different reasons, transparency being one of them. The first active ETFs in Europe (which are not hedge fund ETFs) were launched by Pimco Source early this year. In the fixed income space, actively-managed ETFs make a lot of sense because of some issues inherent to this asset class and to its indices (illiquidity, bloated balance sheet bias, rating restrictions…)

However, on the equity side, active ETFs might find it harder to gain traction because of the daily transparency requirement. The fund industry in Europe, or at least in France, is lacking transparency, so anything which pushes for an increase in transparency is good. These types of products were launched in the US in 2008, but over the last few years inflows have been very small. We’ve tried to understand why people are not interested in this type of product because it brings transparency and active management together, which are just two reasons to be interested.

As you said, Tony, when providers launch these products they have no track record but there are also many so-called active firms that launch funds with no track record at first. So there is no real reason why investors shouldn’t be interested in this type of approach, although there is still a lot of education to be carried out.

Fernandes: While the first ETF was launched in 1993, asset gathering on US ETFs prospered only in years 2003/2004.

End of part 1

©2011 funds europe