The asset management industry has mixed feelings about the long-term threat exchange traded funds pose to index-hugging unit trusts and Oeics
If ETF providers are to be believed, the end may be in sight for passive funds and index huggers, those who demand an active management fee but fail to walk the walk when it comes to performance.
On a statistical basis, there may be some validity to their argument. The IMA recorded net outflows of £2bn from UK-domiciled funds 2008. Sales have recovered since; net inflows were £23.6bn in the black for the first 11 months of 2009. But AUM are only just back to pre-crisis levels, thanks more to rallying markets that renewed investor confidence.
In contrast, BlackRock reports continued rises in ETF assets since the financial crisis began. At the end of 2007, European assets stood at $128.5bn, around £80bn. That rose to $142.6bn by the end of 2008. The latest data to the end of 2009 shows European ETF assets at an all time high of $205.5bn.
For all the coverage given to oil, gold and other commodities, ETCs remain a small part of the market with assets of just $10.9bn. Overall, ETF assets represent just over 2% of the total AUM of European Ucit and non-Ucit funds.
Across Europe
BlackRock reports a growing number of European institutional investors using ETFs on cost grounds. The average equity ETF has a total expense ratio of just 37 basis points in Europe, compared with a passive domestic equity fund’s TER of 87bps.
BlackRock’s iShares division believes Britain’s intermediaries are also keen to use exchange traded vehicles in a wider capacity.
“From the whole of market wrap providers’ data, the quarterly picture shows without question that IFAs are using them as core building blocks,” says Julian Hince, head of business development at iShares.
Intermediary assets in iShares products are split 25% corporate bond, 31% government bond, 19% broad market indices and 15% real estate ETFs.
“That is a broad and middle of the road portfolio. It shows they are not being used as satellite tactical holdings. If that was the case, I would expect to see more esoteric products in the mix,” says Hince.
Evidence from the US market suggests intermediary investors hold ETFs for similar lengths of time as they hold mutual funds, making them strategic not tactical vehicles.
Dividend-paying ETFs also lower holding costs and make them an attractive alternative to long term positions in tracker funds, although Hince admits that some advisers and their clients may stick with the funds they know for comfort.
Lack of commision
Matthew Carr, EasyETF’s sales specialist, believes the lack of commission has held back development of the intermediary market. Once the RDR takes hold, ETF usage in the UK should lead to a wider acceptance across Europe.
“ETFs are a real threat. In the EU, just 10% to 15% of the market is retail. In the US, retail is very active. It has driven down the cost of index funds to similar or even lower levels,” he says.
EasyETF, owned by BNP Paribas, and other providers are lobbying for ETFs to be included in future Mifid legislation. That will increase transparency and make up for the apparent lack of liquidity in ETFs that mainly trade over the counter. It will not increase costs significantly, but will attract more investors.
“The vast majority of assets are in benchmarked products, tracking the Euro Stoxx, S&P and so forth. The next generation includes not just fixed income, but emerging markets, single countries and themes too,” says Carr.
As ETFs can be bought to market faster than mutual funds, providers are already building specialist products with indices based on fundamentals, not just cap sizes. EasyETF’s global agribusiness index has attracted $1bn, posing a real threat to index huggers.
Bernard Henshall, head of multi manager distribution at Scottish Widows Investment Partnership, has no qualms about using ETFs.
“As a multi manager, we have employed ETFs for tactical reasons. They do the job very well. If they are a serious challenge to index huggers, then good. It is not in our clients’ interests to be in expensive funds with a beta of one,” he says.
With hundreds more funds available than there are stocks in the FTSE indices, Henshall is convinced many of them fail to add any value. A switch to lower cost alternatives is a logical move for institutional investors and for individual retail investors, he thinks.
“It is perfectly valid for investors to run them in their portfolios. Of course, it removes one element from the asset allocation decision, but can be worth it by reducing the cost impact,” he adds.
While ETFs may pose a threat in certain circumstances, others believe they and mutual funds can co-exist.
HSBC is hedging its bets. It already has a successful alpha and beta fund range and recently created its own exchange traded fund platform to cater for a different investment market.
Andy Clark, managing director at HSBC Investments, says there is room for both vehicles.
“They can work together. ETFs offer second by second pricing, retail investors simply do not need that level of liquidity.”
Ordinary retail investors and portfolio planners will continue to rely on their mutual funds, a known vehicle with plenty of easy access options for longer term strategic needs. Until ETFs can be bought on the large fund platforms, their mainstream appeal will be limited.
“Portfolio planners will generally continue to use trackers for beta performance,” he says. HSBC predicts passive investment could capture 20% of the global investment market, double its current share in the UK.
