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Detlef Glow, Refinitiv Lipper

European ETFs get top marks in exhaustive Refinitiv Lipper report


Refinitiv Lipper has published its review of the European ETF industry in 2020, entitled Unwrapping the European ETF industry, and authored by Detlef Glow (pictured), Head of Lipper EMEA Research, Refinitiv. 

The data for the survey is drawn from 31 December, 2020, and Glow says: “The European ETF industry is highly competitive, and the promoters have to do their best to adopt to the changing market environment and to fulfil the needs of investors who are looking for tools to implement their asset allocation views as exactly as possible within their portfolios. 

“That said, the success of the European ETF industry may also urge active managers to launch ETFs sooner rather than later, especially as the regulatory requirement to disclose the ETF portfolio on a daily basis might be eased in the near future.” 

Other findings include an observation from Glow that the assets under management in the European ETF industry are highly concentrated at all levels analysed within the study. The 10 top promoters in Europe held 93.29 per cent of the overall assets under management at the end of the year 2020, he says, commenting: “Investors, market observers, and regulators always raise questions about the competitiveness of the European exchange-traded fund industry since the assets under management seem to be concentrated among a few ETF promoters. Generally speaking, I would agree with the statement that one needs to be concerned if a few players are dominating a market, but this seems not to be true with regard to the European ETF industry.” 

Glow notes that iShares, the largest ETF promoter in Europe, accounts in all six periods for nearly half of the assets under management held by the 10 top promoters combined.  

“Despite the fact that the respective market share from iShares compared to the combined market share of the other nine promoters of the top 10 has declined over the analysed six-year period, it has maintained a very dominant market position,” Glow comments. “In any other industry, such a high concentration would be concerning for regulators and clients, as this may lead to a monopoly or an oligopoly, which might bring prices up and/or quality down. In other words, this means it would require a merger of all nine promoters to create a new rival for iShares as the most dominant player in the European ETF industry. Such a move, however, would create an even larger gap between the two top ETF promoters and the rest of the European ETF industry.” 

However, he comments that rather than the aforementioned scenario, he sees falling management fees and a very good quality of products in terms of their tracking of the underlying indices.  

“Compared to their actively managed peers, the European ETF industry looks way more competitive than the European fund industry overall. This is because actively managed funds experienced increasing management fees, even as the concentration of assets under management is way lower than in the ETF space. That said, the ongoing discussion about the value added by active management and the high fees charged by the asset managers, in combination with the rise in popularity of ETFs, seems to drive down the overall costs in this market segment.” 

However, Glow also notes that the falling management fees for core markets are a concern for some market observers since they see the current fee levels for core products as a barrier for entry for new ETF promoters in this segment. “Given the high product quality with regard to index tracking, management fees and TERs have become key criteria in the fund selection process and have driven prices down to a point where only asset managers with decently scaled products can earn money. Even worse, large ETF promoters could subsidise core products over a given time period to gain a competitive advantage over smaller promoters who might not be able to afford such a pricing policy. As the core markets are by nature those markets which are attracting the most investor money, such behaviour by the large ETF promoters can foster a further market concentration, as new ETF promoters may rather launch niche products to avoid the competition with market leaders.” 

Despite all this, Glow finds that new market participants have shown in the past that they are able to gather significant amounts of inflows at the ETF level, especially when they were launching ETFs with innovative investment strategies for core and niche markets.  

“This means that the barriers to enter the market are not too high for new ETF promoters. Despite all of this, one needs to ask whether all of the new market participants will be able to survive in such a competitive environment. It can be seen as a sign of the maturity of the market if an ETF promoter is absorbed by a competitor or is going out of business.” 

On this point, Glow concludes: “As I said before, I am not concerned about the current concentration of the European ETF industry since it is clear that there is strong competition between the different ETF promoters. The investors in Europe can enjoy some advantages from this competition. 

“But I also see that the race to the bottom for management fees has forced some ETF promoters to become creative to generate additional earnings to boost their income. The majority of the ETF promoters in Europe have implemented or extended securities lending programs for this purpose. These strategies are marketed as value-added strategies for investors, as the promoters do share the income from securities lending with investors. From my point of view, however, it is questionable whether these kinds of strategies should be used within investment products that are sold to retail investors. In addition, it is remarkable that the fee sharing models differ from one ETF promoter to another, which means that investors have to do additional due-diligence work to evaluate if a promoter offers a fair fee sharing model or not.” 

On the fees issue, Glow reports that the average TER of ETFs in Europe has fallen from 0.379 per cent to 0.352 per cent over the course of the last five years. 

In terms of ETF administrative support, Glow reports that the market concentration at the custodian level is even higher than at the ETF promoter level, as the 10 top custodians accumulate a market share of 97.23 per cent. Glow writes: “Custodians have an important role within the fund management value chain since they are responsible for the settlement of transactions and transfers of the assets of a mutual fund or ETF. In addition, custodians collect dividends and deal with taxes. Therefore, it can be said that a custodian needs a lot of knowledge to fulfil all these tasks appropriately. This need for specific knowledge might also be a barrier of entry for new market participants. This is because any new custodian would have to build up a skilled workforce and the required technical infrastructure to connect all the dots in the portfolio management value chain from the trading venues and fund managers around the globe to become a viable service provider.” 

Glow comments that it is not surprising that there were a number of mergers of custodians in the past. “As for the ETFs themselves, it looks like size does also matter for custodians. According to the Lipper database, the European ETF industry is using 25 different companies as custodians for their ETFs. Some of the ETF promoters in Europe use service providers from their bank as custodians, while others use external service providers. 

“As to be expected, the assets under management in the European ETF industry are also highly concentrated on the custodian level, as the five-top ETF custodians have a market share 90.18 per cent, while the 10 top custodians accumulate a market share of 97.23 per cent.” 

ESG emerged strongly over the year with Glow reporting that at the end of the year, 152 of the 353 ETFs launched in 2020 had an ESG-related investment objective. This was the highest number of newly launched ESG-related products since the inception of the European ETF industry, Glow writes. “Even as we witnessed healthy inflows into ESG-related ETFs over the course of 2020, European investors prefer actively managed funds when it comes to ESG-related strategies – active funds hold a market share of 83.67 per cent of the assets under management in ESG-related products and a market share of 74.11 per cent of the estimated overall fund flows in these products for 2020 in Europe,” Glow says. 

“With regard to the market share between ETFs and passive funds (index funds), it is noteworthy that ETFs only hold 30.20 per cent of the assets under management of passive ESG-related products, while they have a market share of 61.23 per cent of the overall net flows into passive ESG-related products.” 

Glow writes that there are several reasons why European investors prefer actively managed funds when it comes to the implementation of ESG-related strategies. “One of these reasons is the fact that investors believe that active managers have the chance to outperform their passive peers since they can react faster to bad news that might impact single companies or whole sectors. This is because they don’t have to wait for rebalancing dates to buy or sell constituents of their portfolio. In addition to this, investors believe that active managers are taking more action when it comes to the exercising of voting rights or direct engagement with the management of a company. Another reason why investors in Europe may not use passive products might be the lack of strategies. Since the trend toward ESG-related strategies has picked up significant momentum, there are only a few different strategies used as underlying methodology to create an investible index available at the moment. This lack of investment options might be a hindrance for a number of investors because ESG-related investments are often driven by beliefs and ethical values which investors want to be represented in the investment strategy of their funds. 

“That said, I am sure that this will change over time, as we witnessed the same investor behaviour when the ETF industry started in Europe back in 2000. Generally speaking, it is to be expected that the index, as well as the investment industry, will create an increasing number of indices to fulfil the needs of investors. In that regard, it is also foreseeable that the trend toward ESG-related products will drive future growth for the European ETF industry,” Glow concludes. 

In conclusion, Glow finds the European ETF industry in a good shape and enjoying healthy above average annual growth rates since the introduction of ETFs in the year 2000.  

“The high inflows enabled ETF promoters to expand their product offerings to different asset types and to create innovative investment strategies which should enable investors to implement their market views as exactly as possible within their portfolios. Obviously, not all these strategies met investor demands and were closed after a while since products with low assets under management are not profitable for their promoters,” Glow writes, noting that this behaviour of ETF promoters can be seen as trial and error, but, he says, it is in fact an absolute normal behaviour which can also be observed in the wider fund industry globally.  

“Generally speaking, this behaviour is necessary to drive innovation in the overall fund industry since fund and ETF promoters tend to copy successful strategies from their competitors. 

“The high concentration of the assets under management at all levels of the European ETF industry could be seen as a threat for the overall competition within the industry. Conversely, we still witness declining total expense ratios for nearly all product and asset types, which is a clear sign for a healthy competition in the European ETF industry. Nevertheless, the declining total expense ratios can also be seen as a barrier for the entrance of new ETF promoters. This is because the low level of fees might require very high assets under management in a given product to make it profitable for the respective ETF promoter. 

“That said, we have seen ETF promoters launch new products with a specific investment objective, such as the inclusion of ESG criteria, to differentiate themselves from their competitors. In addition to this, these thematic ETFs do in general charge higher fees than their plain vanilla peers and should therefore be more profitable for their promoters.” 

He writes that the high concentration of the assets under management at all levels of the European ETF industry is not surprising, since higher assets under management lead in general to a higher liquidity of the respective ETFs. “This makes them more attractive for investors, as high liquidity in an ETF reduces the trading costs and the market impact.” 

Looking forward, Glow says that a topic that might become quite interesting in the future is the usage of the different replication methodologies, since European investors prefer ETFs which are using a full or optimised replication approach over those using synthetic replication. This preference started in the aftermath of the financial crisis, when swaps were seen as an additional layer of risk within a portfolio,” he says. “As a reaction to this, the ETF promoters started to create swap agreements with reduced risks. In addition, synthetic replication might be the superior replication method, since the swap contract transfers in theory exactly the return of the index to ETF, which should minimise the tracking error of the ETF.” 

He concludes that the European ETF industry is already an international business with a global footprint and has written a true success story over the last 21 years.  

“Nevertheless, it is to expect that the industry will continue to do so in the future, as there is a trend towards passive investment driven by the low costs and high transparency of ETFs. In addition to this, passive investments seem to be superior compared to their active managed peers since the majority of active managers were over the last few years not able to outperform their market benchmark over long and short time horizons. This performance pattern may change over time, while the cost advantage and the high level of transparency will stay as competitive edges for passive investments,” Glow says. 

“I am expecting that the trend towards ESG-related investment strategies will also become a driver of growth for the European ETF industry, even as we currently see that European investors prefer actively managed funds in this segment. But as non-financial data, which are needed for the inclusion of ESG criteria, becomes increasingly standardised, they can be used for quantitative approaches and will therefore drive the evolution of ESG-related indices which can be used as underlying for respective ETFs. We are also seeing a strong regulatory push toward the implementation of ESG in the EU, such as the Paris agreement aligned benchmarks, which will increase the demand for ETF respective strategies. As transparency is key for these kinds of investments, ETFs might have a competitive advantage here.” 

However, he also says that it is foreseeable that the European ETF landscape will change at least partly over the next decade, even though assets under management are already highly concentrated.  

“I am expecting more mergers and acquisitions on all levels of the value chain within the European ETF industry. One could also expect that the number of ETF promoters in Europe will increase, despite further corporate transactions, as a number of active managers will roll out ETFs as distribution wrappers for their existing strategies since these products will enable them to reach new customers in new markets easily. 

“With regard to the above, I foresee that the European ETF industry will continue to grow at an above average pace and may double its assets under management over the course of the next five to seven years.” 

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