There are now 2379 exchange traded funds (ETFs) globally, with assets of $1,181.3bn (€833bn), a figure that has risen 14 per cent January to October and is expected to top 20 per cent by the year-end as active managers enter the space and alternative asset classes are more widely marketed to retail investors.
Market volatility and uncertainty have been big drivers for ETF growth. According to a recent Greenwich study, ETFs Gain Foothold in Institutional Market, almost half of the respondents use ETFs for tactical tasks relating to managing their portfolios, while 20 per cent use ETFs only for long-hold positions and another 20 per cent use ETFs for both.
High turnover
Providers which offer long and short sector products say the fund flows rotating through the different sectors are large and rapid, indicating many investors are looking to optimise their portfolios by switching frequently.
Demand for ETFs will also be boosted by the Financial Services Authority’s proposals to remove commission bias in financial advice and improve clarity around adviser services. The Retail Distribution Review (RDR) will make advisers describe the service they provide as either independent or, if it is limited to certain investments, as “restricted”. Many advisers are still oblivious that ETFs must be considered as part of the product range, as they fall within the FSA’s definition of packaged products.
“RDR clearly sets the stage for greater use of ETFs than ever in the wealth management space,” says Vin Bhattacharjee, head of EMEA intermediary business at State Street Global Advisors.
“Asset allocation counts for 80 per cent of return, and ETFs are extremely swift ways of expressing an asset allocation view. Wealth managers will be judged on their ability to generate returns so they need to build on their tactical and strategic asset allocation models.”
IFAs and smaller wealth managers are stepping up their efforts to put in place scalable models to sustain their businesses.
“Only a short while ago many adviser platforms did not have the ability to trade shares but infrastructure has improved greatly,” says Dan Draper, head of ETFs at Credit Suisse. “Portfolio managers and investment advisers can use ETFs as a low cost and durable product. We too are gearing our model to help advisers build portfolios.”
There is no single model, however, with almost as many different permutations of portfolio construction as there are adviser firms. Even fund providers such as 7IM, which always focused on active investment, are scaling their infrastructure to build passive portfolios.
Model portfolios
One development is the emergence of model portfolios. “In the past wealth managers typically constructed portfolios using actively managed funds,” says Manooj Mistry, UK head of db x-trackers. “As well as these actively managed fund portfolios, many are now beginning to offer passive versions. These discretionary portfolios are often offered on to financial advisers, who don’t have the knowledge and skill-sets to develop their own portfolios and need to outsource the building of their portfolios.
“These arrangements always existed but looking ahead to RDR, wealth managers are ramping up their businesses because they know IFAs won’t have the ability to manage these portfolios. In five years, most wealth managers will have a set of active and passive portfolios to push out to advisers and clients,” he says.
“In a world where clients want more accountability and competitive pressure is increasing, passive portfolios will also be more common. It is similar to the US a few years ago when stockbrokers set up discretionary portfolios with ETFs,” adds Mr Mistry.
Even big name private banks are constructing passive portfolios, using ETFs to cater for the core affluent market with around E1/2m to invest. For example, ETFs can provide bond exposure in much smaller chunks than the $1m typically required to buy a bond.
Emerging markets
While the massive shifts out of structured products and active funds have now slowed, ETFs are starting to see net new money, and this year there have been particularly large inflows into emerging markets, fixed interest and gold. For example since January db x-trackers’ MSCI EM equity fund has grown from $3.5bn to $5.5bn.
Developed market funds are simultaneously benefiting from investors anticipating an economic recovery. Some $250m flowed into Credit Suisse’s S&P 500 and Nasdaq funds in a single week, immediately ahead of a key announcement on the Fed’s quantative easing in October.
Some investors are still looking for the underlying exposure wrapped with features such as leverage, and ETFs can be structured as the basis for more sophisticated products. For example Credit Suisse investment bank recently launched four structured products based on its 12 new emerging market ETFs.
Long/short and leveraged funds are becoming heavily used by certain asset managers, but not all providers are gunning for these markets.
