Elisa Trovato: In today’s discussion, we will focus on the growth drivers, recent developments and innovation in the European exchange traded fund (ETF) space, as well as potential issues related to product proliferation. Has the financial crisis accelerated the use of ETFs in Europe?
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Eleanor Hope-Bell: The financial crisis was a catalyst event. We saw a shift from active to passive, post 2008. At the time, there was also a shift in terms of ETF types of structures, and counterparty risk came to the fore. Liquidity constraints came to the fore too and ETFs provided intra-day liquidity which many other produts did not. The more investors use ETFs the more sophisticated the uses will become.
ETFs – and we can broaden the category to ETPs – have really disrupted the status quo. They are pushing the boundaries in terms of distribution, cost of distribution and cost of product management, as well as uses of financial instruments.
Kim Hillier: We have seen a strong move towards more investors using ETFs, partly because ability to access different sorts of asset classes and possible exposures has also proliferated.
The asset choices that were on the table only three, four, five years ago were far more limited than now; for instance, many investors may not have been able to consider commodity-types of exposure in their asset allocation, but now, through the exchange traded commodities (ETCs) and the echange traded notes (ETNs), they can gain more efficient access to those non-traditional asset classes which are typically more lowly correlated, and which may in turn improve overall risk budgets.
Christian Goldsmith: While we manage derivatives-based portfolios, such as the Global TAA, for clients who are comfortable with these instruments, in dynamic asset allocation, which is a primarily long-based approach, we mainly use ETFs across a range of asset classes; this was driven by the concerns on short positions and leveraged uses of derivatives that a lot of our clients had, leading up to the financial crisis. ETFs suited them and suited us, as they are a flexible way of implementing our asset allocation views.
However, in some clients’ portfolios we are moving away from a purely ETF-based approach within dynamic asset allocation. In commodities, if a client is willing to let us use a derivative, rather than buying an ETF that buys a commodity swap, we can buy that commodity swap and do that in a more cost-efficient way. There are some asset classes where we do find difficult to obtain a suitable ETF, such as in cash high-yield, local currency emerging debt or small cap equity.
Elisa Trovato: ETFs do not offer retrocessions to distributors. Is that still a barrier to the growth of these passive instruments in the wealth management space? And in which asset class do you use them the most?
Enrique Marazuela: MiFID (Markets in Financial Instruments Directive) requires that we are completely transparent with clients and disclose them the commissions we receive. That will force us to pick the best instrument, as the idea is to charge the customer not indirectly through rebates, but directly through fixed fees. Clients are going to judge us by our results and our performance.
Huge tail risks in active management were something investors were not aware of before the crisis. Now, they want to have a combination of passive strategies, to optimise cost and have a low tracking error, as well as active strategies.
ETFs assets, sourced from both BBVA and third-party providers, represent around 20 per cent of clients’ portfolios, but in the future this percentage will grow. We prefer to invest in the physical, rather than swap-based ETFs. It is very important to assure our customers that they get what they want to buy, such as low tracking error and low cost, and are not running other risks. There may be a lot of factors to analyse in an ETF, but at the current stage of development in Spain, customers are looking for a simple structure they can be confident in.
David McFadzean: We are an active, multimanager business and one of the issues that I have is that we use ETFs the most in niche areas but what I find is the niche areas tend to be the areas where the ETFs are not as liquid. So, just when you need them to provide that liquidity, they do not. I would question whether ETFs are necessarily more cost-effective than actively managed funds. In terms of performance, it is a fact that 100 per cent of ETFs underperform after fees.
Charles Morris: If the underlying is illiquid, then the ETF should avoid that asset class. They should not be in small cap, or exotic emerging markets; they should be in mainstream asset classes.
