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Leading the global investment management discussion

The dizzying new heights of ETFs

Nothing revolutionizes an industry like a new product. This is why Exchange-Traded-Funds (ETFs) have changed the investment management space so much over the past few decades.

The global ETF (exchange traded fund) and ETP (exchange traded product) market is scaling new heights, looking after approximately $5.32 trillion. A number of attendees at Fund Forum International in Copenhagen this past June accept that it is not a case of whether ETFs will accumulate more assets than their active peers, but when.

The growth of ETFs has been quite fortuitous, as their impressive performance has been come off the back of one of the longest equity bull runs in history. Likewise, ETFs have also capitalised on the weaknesses of others, principally active fund managers, whose returns have been disappointing of late.

 ETFs: just common sense?

For many investors, allocating into low cost ETFs (a handful of whom actually change zero management fees) operating in an equity rally makes more economic sense than putting money into pricier active managers, a number of whom are struggling to outperform their benchmarks.

"...The European ETF market is still evolving, although the industry is much less mature than in the US, not least because the region has more stock exchanges and its markets are quite fragmented."

The Financial Conduct Authority (FCA), the UK regulator, has also complained that active asset management costs are uncompetitive, although pointedly said later that it was not endorsing passive strategies over active. Nonetheless, this regulatory intervention may have prompted some institutional and retail investors to park assets in passive funds.

Keep moving, don't rely on one product

Even though ETFs are doing roaring trade, experts at Fund Forum warned that now was not the time for complacency. Brian Kelliher, a partner at Dillon Eustace, said the ETF market in the US was becoming increasingly saturated.

As a result, Kelliher stated that ETFs launching today needed to be innovative and offer something unique and different if they are to acquire scalability and decent investor inflows.

Sean Tuffy, head of market and regulatory intelligence at Citi Custody and Fund Services, agreed, adding that passive strategies were becoming far more innovative, evidenced by the plethora of smart beta, multi-factor ETFs and active ETF products now springing up in the marketplace.

A globally evolving marketplace

Nonetheless, the European ETF market is still evolving, although the industry is much less mature than in the US, not least because the region has more stock exchanges and its markets are quite fragmented.

Europe has in excess of 20 different stock exchanges, whereas the US only has a handful, of which the bulk of ETF listings take place on the DTCC (Depository Trust & Clearing Corporation). Kelliher added the European ETF market was also encumbered by a lack of harmonisation, in terms of its currencies and distribution channels. Likewise, investors are also quite culturally different across the single market.

Tuffy said ETFs made up about five percent of the entire UCITS market, whereas they comprise 15% to 20% of all US mutual funds. He added the European ETF market still had room for growth, which was why a number of US managers were now launching new funds.

Nonetheless, Tuffy pointed out the US and European investor demographics were quite different, and this needed to be taken into consideration. Whereas buyers of ETFs in the US are overwhelmingly retail investors, in Europe they tend to be more institutional. “It is critical that ETF managers get their distribution models right in Europe,” he commented.

In terms of domiciliation, Tuffy said the bulk of managers are going with what they know already, and are listing in traditional fund hubs such as Luxembourg and Ireland. Both jurisdictions, he said, account for around 80% of all EU ETF listings. Of that percentage, Ireland is home to approximately 58% of the ETFs, continued Tuffy.

However, Danielle Reischuk, senior ETFs and ETPs sales manager, Securities and Exchanges at SIX, said Switzerland is  also an appealing listing destination. She highlighted Switzerland has seen a strong  upswing in ETF listings by issuers located in the UK, Germany, France and elsewhere. As a result, SIX is increasingly emerging as something of a powerhouse for ETF listings due to its excellent international reputation and links to Europe.

The B word

Nonetheless, the ETF market in Europe is facing some challenges, not least around Brexit.

"The growth of ETFs has been quite fortuitous, as their impressive performance has been come off the back of one of the longest equity bull runs in history."

Kelliher said the UK FCA had a temporary permissions regime (TPR) in place in what should enable EU-domiciled ETFs to continue passporting into the UK without impediment for three years. What happens once the TPR expires is less known.

Read more of our coverage of ETFs right here