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Off the Record Episode 1
Off the Record Episode 1: ETFs - The salt and pepper in the asset manager soup

ETFs – The salt and pepper in the asset manager soup

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Off the Record Episode 1

Not one, not two but three commentators on the ETF ecosystem have gathered to create ETF Express’s first podcast, Off the Record, in partnership with Truss Edge, providers of front, middle and back-office software and services to ETF issuers.

Listen to Detlef Glow, head of Lipper EMEA Research at Refinitiv, Athanasios Psarofagis, ETF analyst at Bloomberg Intelligence and Beverly Chandler, managing editor, ETF Express discuss European ETFs, their surprising growth despite an extraordinary year in 2022 and market travails, including retrocession; consolidated tape, the rise of active ETFs and the power of ESG.

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Transcipt

Beverly Chandler

Hello, my name is Beverly Chandler and I welcome you to the first outing for Off The Record, the podcast about all things ETF brought to you by ETF Express, in partnership with Truss Edge providers of front, middle and back office software and services to ETF issuers. All views expressed in this podcast are the speakers’ own, and we hope suitably controversial. The ETF industry has enjoyed enormous growth in assets in its short life. We’re recording this around the 33rd birthday of the first ETF on the Toronto Stock Exchange, so happy birthday to ETF’s generally, while state spy State Street spy has just enjoyed its 30th birthday since launch in the US. Assets in the global ETF sector have hovered to just under $10 trillion for the past year in what was universally declared to be an extraordinary year, but apparently one that suited ETF’s. In this inaugural outing of the ETF Express Podcast Off The Record, I bring you a team, including me, whose combined years of experience of observing, commenting, and analysing the asset managed industry are probably longer than the ETF industry itself. So I’m here with Detlef Glow, head of Lipper EMEA Research and Refinitiv and LSEG, he joined the firm in 2005. And then we have Athanasios Psarofagis (Athan) who is an ETF analyst for Bloomberg Intelligence and covers the industry globally with a particular focus on Europe. We’re just going to discuss how this industry has grown from the perspective of professional observers. Detlef, can we just start with if you could tell me how long you’ve been monitoring the ETF industry in Europe?

Detlef Glow

Yes, of course. Hello and thank you for having me. Actually, I don’t want to say I’m a founding member of the industry, but when the first ETFs appeared in Europe in 2000, I was head of research for a wealth management company and we ran some funder funds, and obviously the sales guys approached us with their new product. And after the meeting, I said to my fellow colleague and lead portfolio manager “Why do we need ETFs? What are these things are for? It doesn’t makes any sense”, and actually the my lead portfolio manager, our lead portfolio manager was from the US and he was used to trade ETFs and then he explains to me all the benefits we can have in the asset management from ETFs. And I adopted that to my approach and when I went to my next employee FERRI um we also started to use ETFs and when I moved over in 2005 to, at that point Lipper as a Reuters company um, we started immediately to publish ETF reports on the European ETF industry. So I’m with the ETF industry since the beginning in Europe.

Beverly Chandler

And um if Athan, if you’d like to tell me about how long you’ve been monitoring ETFs in Europe?

Athanasios Psarofagis

Yeah, I’d be happy to and thanks for having me on this inaugural podcast. I’ve been with Bloomberg for five years, so covering Europe there for about four of those five years. But in previous jobs I worked with, I worked at an ETF provider and an index provider, and we had a European business as well alongside a US one, so while maybe not fully in the European coverage until I got to Bloomberg, I’ve always sort of been around product launches globally and I’ve always, you know, had had exposure to the European market.

Beverly Chandler

And so let’s just start with Detlef and tell me about trends you’ve seen on the growth of the European industry over the longer term.

Detlef Glow

Well, I mean the the first trend we see was um was diversification of product ranges and asset types. So when we started, we only had um ETFs on a single index, Equity index. Um it went very fast that the the index coverage in the in the equity space expanded in 2003, we had the first bond ETF, um which then actually laid the growth routes for the trends towards Bond ETFs. But what was really remarkable was that um a lot of these, these um equity ETFs then started to get very, very granular. So we saw the launch of sector ETFs globally. And then we saw sector ETFs focusing on single sectors in Europe, um or in other regions of the world. So um, the ETF industry at that point expected that institutional investors will pick up ETFs as portfolio management tools, which they at that point of time, obviously not did. And so we saw a big wave of launches and afterwards also a big wave of closures of of these products. Um and in the in the ongoing time we saw, as I already mentioned, the trend toward bond ETF and now the the newest trend is in the direction of ESG products. Um I might have forgotten the smart beta trend, which is also still going on. So there’s a lot of stuff going on in the ETF industry and I think this is really the salt and the pepper in the in the asset management soup because the ETF industry is very, very innovative. And brings out products which you mostly can’t make in in the access management space because it would demand so much effort to get those products going.

Beverly Chandler

I’m loving the seasoning approach to put with ETF’s, I think that’s very cool. Athan, do you want to comment on ETF seasoning or not? But also your observation of the taking take up of European of ETS in Europe generally.

Athanasios Psarofagis

Yeah, it’s it’s been really interesting industry to cover because I think everyone always puts it in context in the US. So, so it’s all the where the US does this, it must work in Europe, but I think people need to realise that it’s obviously a very different market. But I think Detlef nailed it in that the the products that have been coming out over the last couple of years have really been able to narrow down different exposures. Obviously ESG is taking up a lot of time and attention both you know in a good way and a bad way. We could talk about this more I think you you’re you know later on, but that’s obviously been a really big focus as well and just more competition. You know over the last couple of years there’s been a lot of new issuers that have come into the market both US firms or asset managers in Europe that are looking to now launch through the ETF, I think that’s something that might continue. You know, whether they want to come in through Active or or something like that, but product proliferation has for sure been one of the the biggest trends. But also just when we maybe thought the industry would plateau. Like you know, lat 21 2021 was record flows, record trading, so the adoption is you know the products are there, but now the adoption is really starting to gain some traction. So I thought that was really interesting, and this was globally. You know there’s there’s a lot of products, but the adoption is really starting to pick up. And I think the trading side really is a really important testament to the to the wrapper and investors being comfortable with that wrapper. So yeah, it’s it’s a long, it seems like a very long road that’s now all starting to cultivate and come together now.

Beverly Chandler

I agree, it does it feels like a long road to me as well. The um the problems that face this in Europe, let’s just we have to look at this. Retrocession, it’s been called the cancer of the ETF industry and now of course, finally we have some small steps possibly to it being dealt with. Detlef do you want to explain what retrocession is and then we can talk about it a bit more.

Detlef Glow

Well, retrocession is a payment from um actually in this case, a mutual fund to the advisor who sold it um to the end investor. This advisor can either be a bank or a independent financial advisor, um so they make a bit of their income um out of these retrocessions. And obviously um these retrocessions leads to higher management fees because somebody has to pay for it. Therefore, the investor pays um the advisor on an annual basis via retrocessions.

Beverly Chandler

And not applicable in the case of ETFs.

Detlef Glow

Right. Because the management fees, I mean, if you have an S&P 500 ETF, for example, with the management fee of below 10 basis points, there’s no room to pay a retrocession in there and most of the ETFs are very cost efficient.

Beverly Chandler

And I think there’s been a study that showed that products where inducements are paid are on average 35% more expensive. And so this is something that’s got to be addressed. And would you like to comment on it, Athan, I think there’s been an initiative at the European level.

Athanasios Psarofagis

Yeah there is, the European Commission, I think, came out and really wants to, you know, look at this very closely. There’s been a couple of regions that have sort of banned it, right? Like the UK and whatnot. But all that said, when you look at the retrocession fees, or maybe that ETF’s aren’t maybe as tax efficient as they are in some other regions. ETFs in Europe are still growing in the face of all that, that’s what I find is so impressive, when you put it in that context that they’re facing all of this and they’re still growing. I just imagine when that retrocession, if ever that gets pulled out, I just think that’s going to be a huge boon for growth. So I think it’s definitely something, you know, the distribution side is definitely, really important to keep monitoring. But and that’s, you know, even within the industry you see a focus on lower cost, right? And so you know Vanguard, even though they’re smaller, have a pretty small market share, they’re growing very quickly where you see flows towards some of the cheapest products. So when that retrocession wall comes down, I think that’s going to be a really big tailwind for the industry, which is already growing, which is. So I always find it impressive that it’s able to grow in the face of a lot of that.

Beverly Chandler

Quite limiting um legislation, I think we did a story about Spain, which has got um a tax advantage for mutual funds. And investors can move between mutual funds and not realise a capital gain which gives them them the edge very easily, but it will be interesting to see and.

Detlef Glow

The pain of truth. For for Ireland.

Beverly Chandler

Oh, really? On that I did not know that.

Detlef Glow

Yeah, it’s in, in Ireland, you’ve got a tax disadvantage as investor for ETFs, and they’re going to work on that. So the EU and the the, the single countries, not the EU itself, has to work on their tech schemes to um make equal tax payments between stocks, ETFs, and mutual funds. And that will be also another boost for the ETF industry, I’m pretty sure about that. And I would assume a higher boost than the the cut and reach recessions because Athan already has um very well observed, um we are, the industry is growing despite all the the the retrocessions and that stuff right.

Beverly Chandler

Thank you. I’m going to go on now actually to consolidated tape because the two subjects are kind of linked really. So we have more news from Europe, thank God. Those of us who don’t actually belong to Europe anymore, we can observe from a distance, but we’ve got this initiative from the 14 European exchange groups to create consolidated tape. Athan this is your chance to explain and and comment please, what is it?

Athanasios Psarofagis

Yeah, it’s. Yeah, it could be quite frustrating and I think this is probably one of the bigger reasons why the market tends to be a little skewed towards the institutional side and it’s just, it could be frustrating because it’s very difficult to get this data, right? And I’m even, I even have a Bloomberg Terminal and it’s very hard to track that data, right? And there are some interesting data providers that are trying to get this this data out to the investors, but it’s very hard to again, I can see that as an investor, that’s very frustrating, right? And um I think that, you know, this has been a unicorn that they’ve been chasing for a long time, right? I don’t know how many times you’ve heard consolidated tape. It’d be, you know, nice to have some sort of tool or something very for investors to very easily compare liquidity, whether it’s at, you know, again at the consolidated level or through pockets through different regions. This would be again another big boon as well, along with the retrocession fees. You know, I remain sort of split on it, you know, they’ve talked about it for a long time. It’s nice to now see all the exchanges get together and there’s this really big push for it. So maybe I’m a little bit more optimistic on it happening. But yeah, I think that’s it’s definitely one, one thing that needs to be addressed for sure.

Beverly Chandler

And Detlef to what? What’s your view on consolidated tape?

Detlef Glow

I think it will be helpful in the markets to view liquidity. It will support the ETF industry as people then see what’s actually is going on and not the fragmented view. But nevertheless, as long as we have all these fragmented exchanges and you can’t cross trade from one exchange to another due to different clearing systems, it’s not very helpful. I mean, you see an ETF, it’s traded on on Xetra for a higher price than on Euronext, you you can’t make anything out of this information um just because you can’t go short on one and long on the other because you can’t have the the possibility to net your book here.

Beverly Chandler

And so do you think going forwards there’ll be more developments that will help defragment Europe?

Detlef Glow

That’s a very, very good question. I mean, the the EU talks about the Capital Market Union, but nevertheless the exchanges are are private uh companies, so they would need to adopt. But I could imagine a world where you see closer cooperations between the the different exchanges.

Beverly Chandler

As they are commercial entities, sometimes it’s easy to forget that.

Detlef Glow

Yeah. Yeah. So I mean, every every exchange has their own clearing house, yeah.

Beverly Chandler

Yeah, yeah.

Detlef Glow

Um and and therefore their own ecosystem for the trades. And that’s that’s that’s one point, and you don’t want to consolidate this because you want to have the competition. But on the other hand side as an investor you want to take profit if someone is mispriced in one exchange while it’s good priced on the on the other exchange.

Beverly Chandler

And let’s just look, because actually that would imply an active investor and that was something else we were just going to look at today is that there seems to be, this year, a rise in launches in active ETF’s. We’ve had the, the, the firm that has given up vowels, Abrdn, which has launched Cummins Week finally in the UK and has launched its active real estate product. And then I wrote last week about Investlinx on the Italian Borsa, which has launched an actively managed portfolio. Detlef tell me your thoughts are, should ETFs be this active?

Detlef Glow

I think so. I mean, the ETF itself is just the distribution wrapper. And you can wrap anything which is under the the fund regulation. So any usage fund could be wrapped into into an ETF. The big question here is when will the EU or ESMA give up on the transparency requirements because ETF’s have much higher transparency requirements than mutual funds. So first thing is you have to ask “Why?”. We know it is because of trading and the efficient pricing. But active managers could unveil their holdings and make official training possible, and I’ve just posted last week a my Friday Facts on on that topic. And actually, Paul Heffernan put a long answer under my post saying he is speaking with a lot of active managers, asked them to join and weigh a white labour platform. And he sees that the more innovative active managers have no issues with unveiling their holdings disclose their holdings to the investors, which is a good sign. And I I see this step when the active managers start to use ETFs as distribution wrapper, I see it the next big growth initiative for the ETF industry in Europe.

Beverly Chandler

Another big growth initiative and Athan, of course in the US you have your semi transparent structure which we don’t have in Europe. But tell me, do you think that will come or something like it will come in Europe?

Athanasios Psarofagis

Yeah, it’s it’s a little. It’s a complicated answer because I think active is a little bit more accepted in Europe than let’s say in in the US, and what I mean by that is that the active non-transparent stuff hasn’t done well in the US in terms of asset raising. But a big driver in the US market for active is taxes, right? And after the SEC ETF rule active ETFs became even more tax efficient than they were. So that’s a really big driver for a lot of the conversions that are happening or invest or these firms wanting to move into active ETF’s. When you don’t have that in Europe, I don’t know how much there is that incentive, right? And so but I think it’s going to be, I think it will be definitely be a way to get some asset managers into the ETF industry, whether it’s non transparent or not, I think it’s going to be at least one way to get them in, so I’m very happy about that. I don’t know how how much the uptick will be just because the tax is such a big driver of it, right? Um and so again, when that goes away, is it just more of a cost issue if I can offer it at a lower price, I think that that definitely could be advantageous. But like Detlef said, when you sort of look at the white space next, you know we’ve done factors, we’ve done thematics, we’ve done ESG, active is sort of the next white space so I think that’s really going to be a big focus for sure.

Beverly Chandler

And I I came to ETF from the hedge fund industry where it was 2 and 20 all those years ago. Not quite the same now, but certainly considerably more expensive, very much more active than an average ETF. But there’s a there’s a nice, big golf in there in the middle of it’s just some sort of fee could be found, surely. This is a talk about ETFs. You have to talk about the ESG because of course it’s the biggest driver in the industry at the moment. Um, Detlef talk to me. I keep saying um. I’ll stop saying um. Detlef talk to me about ESG.

Detlef Glow

Well, ESG, the hot topic in Europe, um and we have the introduction of of SFDR and literally last year everybody had a um, let’s say a light more more light view on the rules and guidelines, which hasn’t been published at that point of time, they need to fulfil to belong to Article 8 or Article 9. And at the beginning of Q4, everybody got shocked, because the regulator technical standards were issued and um the ETF promoters, and the index providers, found out that even if you track the highest standard benchmark, so in EU climate benchmark, you will not be eligible to be an Article 9 ETF or an Article 9 product in general, um because you have to fulfil other um rules to to go under Article 9. So we saw a massive, really massive reclassification if you want to call it that way from Article 9 to Article 8 and from Article 8 to Article 6 and also very few mutual funds that moved up from Article 6 to Article 8. So that there there was a lot of confusion lets say it that way just because the regular regulatory technical standards have have not not been published um at the same date when the SFDR requirements have been published. So um, again, that there was a lot of of reclassification. I had a very nice talk with one of my friends at that time and he asked me well USN ETF specialist and will there be any Article 9 ETF be left at the 1st of January 2023? And yes, there were a few.

Beverly Chandler

So Athan, I quoted you at an event in January, some research you’ve done and I can’t actually remember now, but I know it was really, really intelligent. It was about the um, I think the watering down that’s happened because of this new regulation, so remind me what you what you found.

Athanasios Psarofagis

Yeah I mean one thing that we’ve tracked quite a bit was obviously the the classification that everyone gave themselves, but to Detlef’s point it was sort of just lack of guidance from the regulators. So I think a year ago there was almost 3 or 4% of the ETF’s were article nines. That’s down to less than 1% now because of all these rebrands. And so it’s it’s interesting because I’m sure a lot of people or investors were allocating based on that classification, right? And now all of a sudden they get stripped away and you’re like, oh, wait, now I’m matching an Article 8 fund versus a 9 fund. And so what we’re trying to track now is the one the nines actually do come out of this, are they in a better position, and do they actually end up taking money after, you know, after all this, all these rebrands? But he put it in a nice way, it’s confusing because these rebrands you know, I think there’s a lot of also reputational risk to it, right? You’re coming in as this fund and now you’re being taken back, so it’s something we track very closely um, you know, and there was a pretty big splattering of the ESG launches over the last like 2 years. Something like 50, 60% of the launches had some sort of ESG metric to them. And then that’s not counting all the rebrands, so funds that were not ESG, they added some sort of ESG screen and now all of a sudden they become Article 8 funds um, and it it becomes actually a nightmare to track historically because you’re like well, this is an Article 8 fund today, but it wasn’t an Article 8 fund five years ago.

Beverly Chandler

You’re not comparing green apples with green apples.

Athanasios Psarofagis

Right, exactly. And you’re going through it and you’re like, Oh my, there’s no easy way to to track all of this, so it’s definitely I think the yeah, it it definitely has added a lot of confusion over, you know, the last year or so. Um but it’s something that we track very closely and I don’t know now you know how hesitant, you know, fund houses are going to be to give themselves nine, you know classification versus, you know, does everything just get grouped into eight, but then does that really tell you anything anymore, right? If everyone’s just sort of falling into the same category.

Beverly Chandler

There must be a can. I mean, obviously everybody is terrified of being accused of greenwashing. That that’s the word that we haven’t said and that people are terrified of. Um the we did a study with we interviewed ESG Contigo. Sorry, Contigo talking about ESG appetite and of course, it is much bigger in Europe than it is in America which is interesting. Detlef, has that been not your observation?

Detlef Glow

Yes, but it has to be bigger in in Europe than the US because our rules are so much more tight in direction of ESG. So the EU has given a hard commitment to reach their climate goals and they want the financial industry and therefore the investors to help them reaching this goals and therefore they try to steer with regulation the money in direction of green, whatever this means for the um outcome for the investors. I mean, if you look at last year, money was flowing into ESG products, so light green, dark green, whatever you want to call it. But the best performing asset type was fossil oils, yeah? Sorry fossil energy, oil and gas. So a lot of investors might have been disappointed by by the outcome. This is the nature of the beast. And we will see periods where ESG investing is underperforming and periods where ESG investing is outperforming. And if you look on the on the corona crisis in 2020, obviously with the oil price dropping below 0, ESG funds had it had a very good outperformance. Uh in 2022, sorry, in 2021, the the ESG funds had a good risk adjusted performance, or a better risk adjusted performance, and in 2022 the the the winds completely changed so we saw that the brown industries are are going upwards. And I think it is it is wrong to say that ESG can’t be the the the the um superior investment style because every style – think about growth and value, small cap large caps, has times where it out and underperforms. So I hardly understand why ESG got blamed for the underperformance of last year.

Beverly Chandler

And Athan do you want to just add to that?

Athanasios Psarofagis

Yeah, it seems like ESG’s an easy target, I think Detlef put up a really good point is that yeah, you know, you know, if energy doing really well, traditional energy, like the oil companies and whatnot, yeah ESG’s going to underperform. But I think the other thing that people need to really focus on is things like voting, right? So how how was the asset manager a steward of your votes and things like that. So I think there might be a bigger focus on that, but yeah, it just seems like an easy target, I think the issue gets easily politicised very quickly and it strikes a nerve with a lot of people. So it seems like the industry’s still sort of maybe trying to figure out what’s the optimal way to to do ESG. Is it through these funds? Is it voting? Is it setting up as a non profit? And all of these are sort of being tried, but I think we’re still sort of going through the labour pains to find out what’s the best way to do it.

Beverly Chandler

Yeah, it’s an evolving and and new evolving industry. Look, thank you so much, we’re out of time and you two have been amazing. I want to thank you for being my guests on this inaugural Off The Record. And this is Detlef Glow, head of Lipper EMEA Research at Refinitiv, and Athanasios Psarofagis, ETF analyst at Bloomberg Intelligence, thank you for your time. And I want to thank the listeners, thank you for listening at our first outing for Off The Record.

Outro

Off the record is brought to you by ETF Express in partnership with Truss Edge, providers of front middle, and back office software and services to ETF issuers. Production by Imogen Rostron and Lisa Hines, and music by Otto Balfour. Thank you to our guests on this episode of Off The Record from ETF Express and to you for listening. We look forward to you joining us next time.

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