By James Williams – As the winners demonstrated at the etfexpress Global Awards 2013 presentation, sponsored by Lyxor Asset Management and held in London’s Mayfair last month, the global ETF market continues to grow from strength to strength.
Year-on-year (through November 2012, based on ETFGI’s global ETF and ETP insights report), the number of ETFs increased from 3,025 to 3,336. Total ETF/ETP assets also increased, from USD1.526trillion to USD1.688trillion.
Sunil Gopalan, etfexpress Publisher, notes: “At this rate, the ETF market will rival hedge funds; even though total hedge fund assets reached USD2.25trillion in 2012, hedge fund assets have not gained significant traction post-08.”
So anyone who doubts the importance of the ETF market is somewhat in denial. Factor in that there remains huge growth potential in Europe – with the US having led the way for the last 20 years – and there’s a lot to be excited about for ETF providers.
Indeed, 2013 looks to be continuing in the same vein as 2012. According to the latest ETFGI report, ETFs and ETPs posted net inflows of USD11.4billion globally in February. The biggest recipients were Equity ETPs, attracting inflows of USD11.6billion: a clear signal that investors have rediscovered their risk appetite. Fixed income ETPs, by comparison, attracted a mere USD1.3billion, while commodity ETPs – always a tricky asset class for investors – suffered net outflows of USD4.9billion. Year-to-date (through end-February), total net inflows for ETPs stand at USD49.1billion.
It’s far too early to summise how the rest of 2013 will play out, but if equity markets are given the chance to trend, equity ETPs could be the real winners.
Even last year, equity ETPs dominated inflows by a factor of two. Whereas fixed income inflows stood at USD61.3billion for the year through November 2012, equity inflows were USD126.9billion. That equates to a healthy market share of 66.4 per cent. Geographically, North America dominates with just over 50 per cent market share. Perhaps more revealing is that Emerging Market equity ETPs have nearly twice the market share to that of Europe: 19.6 per cent compared to 10.4 per cent.
Within that context, Claus Hein, Head of Lyxor ETF Institutional Sales for the UK, Netherlands and Nordics at Lyxor Asset Management, confirms that Lyxor – winner of Best Emerging Markets Equity ETF Manager this year – has already had a positive start to the year “in terms of inflows and overall turnover across the EM range.
“Specifically, the Lyxor ETF MSCI Emerging Markets has been very popular as investors have been adding to their broad global EM allocations. The fund has raised about USD200million in net new assets year-to-date. Notably, there has also been activity in the four main BRIC country funds with China still being particularly attractive to many clients.
“On the Fixed Income side, investors are expressing interest for an expanded set of EM Debt funds in addition to our existing USD-based product so we will continue to monitor this space,” confirms Hein.
One emerging trend for investors to keep track of within the ETF/ETP market, is the increased level of innovation being brought to bear by fund providers. ETFs, quite rightly, have long been viewed as merely passive products, constructed of a basket of securities that track an underlying index.
But whilst the role of traditional benchmark indices remains vital, it is no longer exclusive. Secondary indices, which offer slightly more tailored exposure, are providing enhanced returns. In addition, smart beta and actively managed ETFs – whose objective is to generate alpha like their hedge fund counterparts – are also gaining traction as the ETF market evolves towards offering more “value-added” strategies to investors.
One European ETF provider, in particular, leading the way in innovation, is Source: winner of three awards this year – Best Alternative ETF Manager/Most Innovative European ETF & North American ETP Provider. Among its suite of 86 ETPs, 14 of them fall into the value-added strategy bucket (11 of them are smart beta, three are alpha strategies).
Michael John Lytle, Chief Development Officer at Source, says that while Source will continue looking to increase the number of value-added products, it would only ever be done in proportion to the number it currently offers. “When you put on these value-added strategies, you do so in smaller numbers. They take a lot of work; you don’t just roll them out in batches. You have to go out and tell the story, do roadshows etc.
“We don’t plan to skew our offering into the beta plus and alpha space to the detriment of our primary and secondary benchmarks; these remain core to us. I think we could add more primary and secondary benchmarks in the fixed income space, for example. We currently have seven products and while we cover high yield bonds, active cash management strategies and select sovereigns we see opportunity to offer a wider spectrum of products.”
A great example of where innovation is taking place is precisely within the fixed income space. PIMCO – winner of this year’s Best Fixed Income (excluding cash) Manager – has developed a suite of indices that better reflect the way the world has changed in recent years. Most fixed income indices are market capitalised-weighted, which simply means that investors end up allocating more to countries with the highest level of indebtedness.
What PIMCO has done is develop three GDP-weighted indices that provide investors with higher exposure to stronger countries – particularly Emerging Market countries like Brazil – whose debt to GDP ratios are much lower than those of developed countries.
The three GDP-weighted indices are: Global Advantage Bond Index, Global Advantage Government Bond Index, and Global Advantage Inflation-linked Bond Index. In addition, PIMCO has developed three actively managed ETFs – available in USD, GBP and EUR – that are designed to help investors overcome the challenges of cash management at a time when holding cash has become an expensive exercise.
“For cash that clients don’t need to use for up to six months we actively invest in low duration investment grade securities with an average maturity of less than three years. We can buy and rotate through a range of different short-term instruments to ensure that yields remain positive. For instance, through careful security selection, exposure to state-run agencies that are explicitly government-guaranteed can offer additional yield from a liquidity premium without sacrificing quality.
“A typical benchmark for EUR cash returns is EONIA, which returned 0.23 per cent during 2012. But through active cash management, our EUR short maturity ETF returned net-of-fees 2.54 per cent during the same period,” explains Howard Chan, ETF portfolio specialist for PIMCO.
Another key area of innovation for ETFs is pricing. With so many providers out there, being able to offer a cheaper Total Expense Ratio than one’s competitors is vital. This is something that firms like Source are all too aware of – its Source Physical Gold ETC is now one of the most liquid and cost-efficient products with a 0.29 per cent annual fee.
UBS – winner of this year’s Best Europe Equity ETF Manager – has developed a dual share class model to tackle the cost issue. The A-share class model is priced like all other ETF products in the market. By comparison, the unique I-share class model is aimed more at institutions who buy large blocks of ETFs, and who can now enjoy a large discount in management fees.
Explains Clemens Reuter, Head of UBS ETFs: “We are the cheapest in Europe, which also comes through in the performance of the product. Our products perform well on the portfolio management side, they have a unique pricing structure due to our dual share class model, and on top of that we have an excellent security lending model which provides our funds with additional revenues.”
UBS certainly made a big splash when it listed 66 ETFs on the London Stock Exchange last June; the largest ever ETF listing on the exchange. Across all markets, UBS enjoyed positive net inflows in 2012. This, says Reuter, “confirms that we were justified in our decision to expand our distribution capabilities and confirms that our thinking was correct”.
UBS offers 46 ETFs on equity benchmarks, and for the vast majority of them this dual share class model is available to investors. Given the firm’s long track record in passive management, it is unsurprising that UBS moved into the ETF market several years ago.
“We use heavily automated processes and I think that’s where we, as a large global asset manager, have a natural advantage; you need to be a precise passive manager to be successful in the ETF space,” adds Thomas Merz, Executive Director, Head UBS ETF Switzerland & Liechtenstein.
Lyxor’s Hein adds a further comment in relation to costs, using Emerging Market ETFs as an example: “We think it is critical to minimise overall implementation costs to maximise investors’ experience when investing in EM ETFs. As volumes keep growing and more clients increase their ETF usage, we will further develop our relationships with market makers and ETF Authorised Participants to ensure spreads and trading costs become even more competitive for EM products.”
Indeed, the role of market makers cannot be understated. With such an enormous variety of products and asset classes within the ETF market, providing the necessary liquidity – which in turn helps keep bid-offer spreads as tight as possible – is one of the most important underlying functions.
Firms like Flow Traders – winner of this year’s Best European and Asia Pacific Market Maker – are focused on providing institutional investors with highly competitive bid-offer prices on an OTC basis for any ETP, “from all issuers and with reference to all major exchanges world-wide, including pre-market and after-close trading”, comments Bernardus Roelofs, Global Head ETF Sales Trading at Flow Traders.
“The team is in close contact with asset managers and supports them as well with the selection of ETFs and knowledge sharing on when best and how to trade. With the increasing number of ETFs worldwide, the different structures, fees, TER, tracking errors and all the various trading venues, this know-how is ever more vital,” adds Roelofs.
For Europe in particular, the ETF market remains an exciting and vibrant place. The opportunities for providers are huge. But with so many products to choose from, providers have to continue to push the envelope: be that through offering niche strategies, access to new markets, low TERs, working with more Authorised Participants, developing “value-added” strategies that move away from pure passive investment.
But ETF providers should, at the same time, not get too carried away. In Europe, there remain a huge number of investors who still don’t understand ETFs and have never invested in them. With the introduction of the Retail Distribution Review in the UK, which removes fee commissions, the idea is that independent financial advisers will start looking beyond products they sold historically.
Deborah Fuhr, founder of ETFGI – winner of this year’s Best ETF Research Provider – comments: “There’s still a large need for education among investors on the benefits of ETFs.”This, she says, could well result in the more plain vanilla, easy to understand ETF products, attracting further inflows in 2013 and beyond, as investors become more familiar with the market.
“The first place many investors choose to invest is in physical gold so I would expect to see continued inflows into physical gold products going forward.”
