At the same time, the ETF market has developed funds in a very wide range of geographies and sectors just when investors have come to truly believe in the mantra of diversification and at a juncture when they are most cynical about active management.
Then there is the Retail Distribution Review (RDR) in the UK which will prohibit commission, so cheap, non-commission products will suddenly start to look more attractive. The new RDR regime is also encouraging big advisers to put together off-the-shelf model portfolios, which generally have an ETF component to keep them competitive on costs.
The flexibility of ETFs means they can have one purpose one day and a completely different purpose the next; they are used widely both as tactical instruments for active trading and for buy and hold investments. Currently, the style of use varies by region, according to Alexandre Houpert, head of exchange traded products for the UK and Northern Europe at French funds house Lyxor. “The UK is still asset allocation driven and portfolios are more often constructed entirely out of ETFs, but in France and Germany they are more frequently used as a trading tool,” he says.
At multi-manager FundQuest, which focuses on active managers, ETFs account for just 10-20 per cent of portfolios, and are primarily used tactically for short-term holdings of one to three months, owing to their liquidity. As a supreme example of liquidity, the SPDR on the S&P500 trades more than any security in the world – four times more than the next most traded security, Apple.
TRADITIONAL USES
Traditionally ETFs have been used within multi-manager operations in the UK for structural exposure to more efficient markets such as the US. An ETF may typically be used for core S&P 500 exposure, with two to three active managers positioned around it.
Other markets are now habitually considered difficult to succeed in, however. “ETFs are useful for exposure to the Euro Stoxx as there are also many managers in those markets that we are not confident will add significant value after fees, and for smaller esoteric asset classes where an active manager may not be available such as parts of the property markets in the US and Europe,” says Hans Hamre, research director at FundQuest Europe.
A similar argument can be applied to individual developing country funds where managers may not have a long track record and there is above average manager turnover. “We want a high degree of certainty about the managers’ style – that whatever it looks like now, it will still look like that in six months, and we prefer track record of more than a few years as recent years have experienced only a small part of the economic cycle,” adds Mr Hamre.
There is also the consideration of scale and the need to be able to accommodate large investments – some small active funds of $50-$100m (E37-E73m) may not cope well with large inflows and outflows.
A look at the table opposite shows how much the market has developed, and how the universe of funds and providers has expanded. In 2009, six of the largest funds in Europe were managed by iShares, with the top spots going to the S&P 500 and FTSE 100 respectively, while four funds in the top 10 were overseen by db x-trackers.
In this year’s table, the listing includes a wide variety of providers such as ZKB, ETFS, Credit Suisse and Lyxor. The largest fund is the iShares DAX, which at E10.7bn is more than twice the size of the 2009 leader. The switch out of broad eurozone indices and into the DAX is a clear flight to quality and a reflection that Germany is the largest ETF market.
Four of the largest funds track the price of gold bullion. Investment in precious metal ETPs (exchange traded products) has ballooned to $141bn industry-wide, compared with $123bn at the start of the year, and just $14bn in 2006, and according to Barclays Capital, this bull has run far enough.
REPLICATION
Debate on the structure of ETF replication came to a head in the summer as lobbyists whipped up concern about the risks of swaps and securities lending, educating the marketplace in the process.
A new set of guidelines is now expected from the European Securities Markets Expert Group in the middle of next year. Practitioners say that standards in the ETF industry are already high and as securities lending and derivatives are not unique to ETFs, any new restrictions should embrace the whole marketplace, as will be the case in France, rather than targeting only ETFs which account for less than 3 per cent of the fund universe.
