ETFs: we have lift-off

Manooj Mistry, head of structuring at db x-trackers, says: “Our private equity ETF was launched a couple of years ago, which was bad timing, but in the last three months funds of ETFs have begun using this product for their private equity exposure.”

Launched in January 2008, the private equity ETF tracks an index which is designed to reflect the risk and return characteristics of the 25 global most liquid listed private equity companies covered by LPX, the listed private equity index provider.

The private equity ETF is just one of the alternative ETFs db x-trackers has launched. Others include hedge funds ETFs and leveraged products. The firm is planning to bring some more leveraged ETFs to market.

Interestingly, according to figures from the Lipper research series, “other” ETFs have not performed too well. The research shows that 30 of the 61 funds in the “other” segment analysed in the reporting period (between December 2008 and December 2009) generated negative performance, with short or inverse funds performing the worst.

The reason for this negative return is due to the market environment. Detlef Glow, head of Central, North, and Eastern European research at Lipper, says: “In a negative market environment short ETFs will lead the performance table, while in a positive environment leveraged long portfolios will be on top.”

But essentially, these performance figures would not make any difference to db x-trackers’ forward trajectory because Mistry says that it’s all about offering the broadest range of products possible.

He says: “We’re quite neutral about what people invest in, we just want to provide them with choice.
“It’s also about having the right products available at the right time. Last year, people were looking for alternatives, in search for returns uncorrelated to equities as markets plunged.”

And this year, the improved flows within the private equity ETF show that this has not stopped.

Active use
ETFs have been on a high since the financial markets plunged in 2008 and investors became more risk averse. Lipper statistics show that the AuM of ETFs traded on European exchanges reached a new all-time high, with the assets of €162.49bn in December 2009, compared to €110.26bn in 2008. This means the AuM in ETFs increased by 47.4% in a year.

Without a doubt, the huge uptick in ETF subscriptions sparked a discussion that pit active management against passive products. But now, according to Mistry, active managers are beginning to find value in using ETFs.

Mistry says: “Most asset managers seemed to be stock-pickers, those who could identify attractive investment opportunities in the market. There is now the realisation that the market is changing. Rather than try to identify stocks, some active managers are becoming asset allocators.

“They are seeing that they are not going to beat the market by identifying the best stock out there but can do so by deciding which particular country or sector or asset class they should be investing in and when.”

He says that ten years ago, when he worked with Merrill Lynch and launched the first ETFs in Europe, active managers would always refuse to put their money into ETFs, saying that their value added is  in identifying stocks.

“But now there’s been a complete turnaround and more people want to know about ETFs.”

According to Mistry, the use of ETFs should not be about passive versus active management. He says: “ETFs can be a flexible investment tool. Passive and active management don’t have to be mutually exclusive, with ETFs they can be complementary to one another.”

He says that ETFs can be used within an active portfolio to complement the skills of the fund manager. “There are some markets, especially developed markets in the current environment, where most fund managers underperformed the index. So, for improved returns, it makes more sense for investors to stick their money into an ETF then pay for underperformance from an active manager,” says Mistry.

Funds of ETFs
It has been known that active managers began using ETFs either for their core holdings or for tactical plays and now some managers are even rolling out a new raft of products or services on the back of ETF investment.

Mistry says: “There has been an increase in the creation of funds of ETFs. Managers behind such products provide value added by thinking about the timing of the asset allocation decisions. They use their skills to analyse market data and decide which asset classes to invest in and when.”

Evercore Pan Asset Capital Management recently launched two funds investing in ETFs. The firm says: “Studies show that it is asset allocation rather than stock-picking which is the key determinant of the level of long-term investment returns.

“Over time, few active managers ‘beat the index’ and many suffer periods of damaging underperformance. For investors whose own experiences and observations have led them to share these conclusions, ETFs are an ideal way forward.”

Pension funds and private wealth
These low-cost solutions may also help increase the uptake of ETFs by pension funds and private wealth clients. According to Mistry, the appetite for ETFs on behalf of this client segment has been increasing.

He says: “We’re seeing higher adoption of ETFs within these client segments, which is positive and dynamic. There has been global adoption of ETFs. The Nordics were early adopters – pension funds in the Northern part of Europe will happily make their own asset allocation decisions and are therefore happy to invest in ETFs.”

The next big hurdle for ETF providers to get over in terms of penetration is the UK. Mistry says: “In the UK adoption of ETFs has been low, since pension funds’ investment decisions are highly driven by investment consultants. But there is growing interest in ETFs on behalf of private banks, for the sake of competition. The use of ETFs allows them to reduce their cost, get better performance and broader exposure.”

©2009 funds europe