Published in Markets Media Magazine
Television viewers in England can currently see adverts encouraging them to buy tickets for three American football games in London later this year. The NFL will be hoping it can extend its international franchise as successfully as US exchange traded-fund issuers. Some US firms have already gathered large amounts of assets in Europe and more are expected to launch into a fast-growing market.
The ETF/ETP industry in Europe gathered a record $62bn in net new assets in 2014. As a result, assets in European ETFs/ETPs at the end of last December reached $460bn according to consultancy ETFGI. The consultancy predicted that the region will break through the $500bn barrier this year.
iShares, the ETF arm of US manager BlackRock, had the largest assets in Europe at the end of last year, followed by Deutsche Bank’s db x/db ETC and Societe Generale’s Lyxor AM in third place. The top three issuers had a combined market share of 68.2%, down from 70.7% in 2013 said ETGI.
Deborah Fuhr, managing partner of ETFGI, told Markets Media: “BlackRock lost relative market share and would have lost more if they had not acquired Credit Suisse’s ETF business. There are also strong European issuers in the market.”
ETFGI found that during 2014 iShares’s market share fell from 48.1% to 46.2%. For db x/db ETC and Lyxor AM, their shares remained flat from 2013 moving from 12.1% to 12% and from 10.5% to 10% respectively.
BlackRock completed the purchase of Credit Suisse’s ETF business in July 2013, extending the US firm’s footprint in Switzerland.
Buying In
Acquisition is one way for US firms to enter the Europe market. Last year WisdomTree acquired Boost ETP and established WisdomTree Europe while US private equity firm Warburg Pincus bought a majority stake in Source, another European ETF issuer. Lee Kranefuss, a Warburg Pincus executive in residence and the former chief executive of iShares, joined Source as executive chairman.
Another approach is to build an ETF platform like Vanguard Asset Management or State Street Global Advisors, through its SPDR ETF unit.
Alternatively, US issuers can partner with a European provider. For example, Source issues some ETFs for Pimco, the US fixed income manager. “ETF Securities is canvassing potential partners and other US firms are looking at the European market,” said Fuhr.
She added that new entrants need to ensure they have an ecosystem to support their products such as sales distribution, capital markets, and a well-designed compensation policy, as ETFs have lower margins than mutual or active funds.
Caroline Gutman, passive fund analyst at Morningstar, said US issuers have seized the opportunity to expand in a less developed market. She added: “Vanguard has been doing very well and First Trust Advisors and WisdomTree are also picking up flows.”
Jonathan Steinberg, chief executive and president of WisdomTree, said in email to Markets Media that since launching its European operations, the firm has issued a select range of UCITS ETFs under the WisdomTree brand while continuing to manage and grow the range of short and leveraged fully collateralised ETPs under the Boost brand. “Expansion into Europe, the second largest ETP market after the US, allows for WisdomTree to further participate in global ETF market growth,” Steinberg added.
UCITS funds can be marketed across the European Union once they have been authorised in one EU member state. They can also be sold overseas in Latin America and Asia, but not in the US.
Simon Klein, head of exchange-traded product distribution & institutional mandates, EMEA and Asia, at Deutsche Asset & Wealth Management, said: “UCITS product structures can be more efficient for Asian investors than US-listed ETFs. That is a significant factor, and we will develop products with this in mind.”
Vanguard began to compete in the European ETFs in 2012. Tim Huver, ETF product manager at Vanguard said the firm had gathered $15.1bn of assets in its 13 European ETFs by the end of last year. “We had the second-highest European cashflows of $10.5bn in 2014,” he added.
Huver said Vanguard’s philosophy is the same in Europe and the US although implementation has to differ in the more complex and fragmented European market.
“We excel in indexing and bringing high-value products at the lowest cost,” he added.” We can use our existing ETF infrastructure in building product and managing products but we need to tailor many features for Europe.”
In December Vanguard said costs for its European ETF suite ranged from 0.07% to 0.29%, compared with an industry average of 0.35%, after it lowered charges last year.
Ownership Costs
Alexis Marinof, head of SPDR ETF in Europe, Middle East and Africa, said the total cost of owning ETF exposure has three components – management fees, trading costs and the cost of accessing the asset class, including tracking error. He added: “The European market is very well priced and competitive. Last October we reduced the total expense ratio for 15 equity and fixed income SPDR ETFs and in December we cut the prices of two additional SPDR ETFs.”
The SPDR business is embedded in SSGA and Marinof argued that it benefits from using the same portfolio advisers. In 2010 the firm decided it had to do a better job on focussing on ETFs in Europe.
“Three years ago we had 13 ETFs with €1bn in assets and last year we had 60 different ETFs with a total of $11.2bn in assets,” he added. “We will grow our products this year and remain a very strong force in innovation.”
Alexis Marinof, SSgA
Marinof said European investors are increasingly comfortable with fixed income ETFs as shown by the doubling of flows in 2014. “We have delivered beta in equity and fixed income for many years so we are very well positioned for this,” he said. “Last October we were the first to issue a global convertible bond ETF and we have had a lot of success with emerging market local currency debt ETFs.”
Europe has traditionally favoured equity ETFs but Deutsche AWM expects fixed income to be the main growth driver, especially high-yield products, given near-zero interest rates. “Here we launched the global aggregate bond ETF, which was the first to track the 16,000 components of the Barclays Global Aggregate Bond Index. It has gathered just under €500m so far,” said Klein.
In January this year Deutsche AWM launched three European high-yield corporate bond ETFs. Klein added: “The one with duration of less than two years – the db x-trackers iBoxx EUR High Yield Bond 1-3 UCITS ETF – yields close to 4% and we are the first to market with that exposure, so it could be a blockbuster.”
Deutsche AWM said that last year it had €4.2bn in inflows. In total, the firm has crossed €50bn milestone in assets under management for the first time according to Klein.
Detlef Glow, head of EMEA research at Lipper, the fund research provider does not believe that US issuers have a competitive advantage when entering Europe as they cannot just convert US funds, but need to set up a new business and new funds.
“US issuers need to ask where they can add value,” Glow added. “There are already thousands of funds listed on European exchanges and the vanilla equity and debt space is already crowded.”
Glow said European issuers can compete by developing innovative products. He gave the example of the partnership between Edhec-Risk Institute and ETF provider Amundi to create smart beta passive products for the institutional market.
Innovation in bringing new exposures to the market, a move to physical replication ETFs and the introduction of low-cost ETFs were three components of a growth strategy that Deutsche AWM implemented last year.
ETF Replication
Klein said Deutsche AWM shifted around 40 synthetic ETFS into physical and the firm is the number two provider in Europe with €20bn in assets in physical ETFs. “We still have approximately 180 synthetic ETFs, and it is a key capability in our strategy to offer both replication techniques,” he added.
Last year Deutsche AWM launched the first physical ETFs on the CSI 300 China A-Shares index, which were listed in US and Europe and have gathered more than €1bn.
Deutsche AWM also introduced core ETFs with total expense ratios starting at seven basis points to attract new clients who previously only used index funds or rolling futures strategies.
ETFs have traditionally been more expensive in Europe that the US due to the fragmented market. They can be listed on a number of national stock exchanges and then have to settled locally in the national central securities depository of the exchange where the trade is executed. There were 2,106 ETFs/ETPs in Europe at the end of last year with 6,376 listings on 26 exchanges according to ETFGI.
As a result market participants need to have accounts with multiple national central securities depositories in order to move ETFs between countries, reconcile their positions and to follow different post-trade market practices in different markets. As a result ETFs in Europe have traditionally traded at much wider spreads than in the US. To reduce costs Euroclear Bank, the international central securities depositary, has pioneered an international structure which was used last year by Pimco and iShares. Last October SSgA became the first issuer to migrate 13 ETFs from a domestic to the international structure, which allows trades to be settled through one central CSD, regardless of the listing.
Hazell Hallam, UK ETF leader at PwC, said: “Initiatives such as the use of a single European CSD will improve liquidity, ease cross-border processing and lower costs which can only be a good thing.”
Hallam added that the European market will come under increasing cost pressure as it matures.
In a report “ETF 2020: Preparing for a New Horizon” PwC said that only a handful of European managers are now offering active ETFs but that will change as large US houses look set to bring active ETFs to region. PwC surveyed executives from 60 firms around the world who account for more than 70% of global ETF assets.
The survey said ‘smart’ beta products, those that follow index weightings based on factors other than the standard market capitalisation, represent a hotbed of product development activity. PwC added: “46% of all survey participants identified this as the most important area of innovation. Among non-US firms, it ranks first.”
Strategic v. Smart
A report by Morningstar last year found that as at June 30 2014, there were 673 strategic beta ETPs globally with collective assets under management of $396bn. Morningstar prefers strategic beta as it said ‘smart’ beta has positive connotations that may not always be warranted. Unsurprisingly the US, the most mature market, accounts for nearly 91% of these global strategic beta assets.
There were 139 strategic-beta ETPs listed in Europe with $26.3bn of assets under management at the end of last June, up from $3bn at the beginning of 2009.
Morningstar said: “The European market for strategic-beta ETPs has not only posted strong growth rates over the past few years, but it has also outpaced the European ETP market as a whole. While these products represented only 2.1% of total assets in European ETPs at the beginning of 2009, they reached 5.6% of that universe as of end-June 2014.”
In Europe dividend-focused strategies were the most popular with 61.3% of total strategic-beta ETP assets, compared to 30% in the US.
Morningstar said: “In stark contrast with the US, growth strategies have failed to gain any traction in Europe, with less than 1% market share. This probably underscores cultural differences, with European investors not considering style as important a component of their investment decision as US investors do.”
iShares was the largest European strategic-beta ETP provider with $11.8bn in assets at the end of June 2014, followed by SPDR with $3bn and Source in third place.
Klein agreed that more smart beta products will come to the European market but warned that they are strategic investments which need a lot of investor education. “Newer asset classes, such as high-yield fixed income, have higher growth potential, at least in the short term,” he said.
Three quarters of the PwC survey participants expect global ETF assets to at least double and reach $5 trillion or more by 2020.
Klein said: “The growth potential in Europe is so huge. We predict a 20% growth rate per annum, with a higher rate in fixed income.”
In Europe just 3.5% of assets in mutual funds are in ETFs compared to 14% in the US.
Marinof said there is no reason why Europe should not eventually catch up with the US. “We have done a lot of work to enhance infrastructure, diversification and investor education, but we are not complacent and this will not happen in the next couple of years,” he added.
Lipper’s Glow is also not being complacent. Last November he wrote a piece titled “Is the Success of ETFs in Europe Only a Myth?”
Growth Parsed
Glow argued that the overall growth of the European ETF industry has been driven mainly by the general inflows into mutual funds, of which ETFs are a part. Lipper analyzed the market share of ETFs from the estimated net flows for European mutual funds from all asset classes and found that the share of ETFs from net new sales fluctuated between 5% and 15%, peaking between the 2008 credit crisis and the Eurozone government debt crisis in 2011.
“The development of the ETF segment was a real success story in the past. But to maintain success as a growth segment in the future, ETF promoters will need to unlock the potential of all kinds of investors and sales channels to ensure the market share of the overall net new sales increases,” Glow added.
He was optimistic that issuers in Europe will do their homework and that ETFs should be able to increase their market share and enter a new growth path.
The European ETF market has been dominated by institutions, while in the US there is a far greater penetration amongst retail investors.
The recent Greenwich Associates 2014 Continental European Investment Management Study found that 25% of European institutions use ETFs in their portfolios, with public and industry pension funds heavier users than corporate schemes. The consultancy said that institutional use has been relatively steady since 2011, when 24% were using ETFs. In comparison only 14% of US institutions were using ETFs in 2011 and that has risen to 20% today.
The survey found that 22% of participants expect to increase their ETF allocations in the next three years with one tenth expecting to increase allocations by more than 10% within that time.
Greenwich Associates said: “Much of that expansion will occur in equities, where institutional use is by far the highest. But robust adoption rates in fixed income and experimentation with ETFs in new asset classes such as commodities will also drive ETF growth.”
The consultancy said ETFs will receive a further boost as institutions gradually relax conservative internal investment guidelines limiting or prohibiting their use.
Hallam said new regulations in Europe such as MiFID II and the UK’s Retail Distribution Review could be a game changer for the sale of ETFs to retail investors. Independent financial advisors previously had little incentive to sell ETFs that did not pay commissions, but this practise will be banned under the new rules.
MiFID II will not come into effect until 2017 but PwC said a number of countries including Germany, Switzerland and the Netherlands have already enacted legislation to ban commissions for fund sales.
The effects can be seen in the Netherlands where Euronext launched options on six iShares ETFs on its Amsterdam derivatives market in January this year. The exchange said in a statement that the recent abolition of distribution fees in the Netherlands has increased interest in ETFs. Over the last year ETF trading in Amsterdam increased by 40% and assets under management of Dutch-domiciled ETFs listed on the exchange more than doubled.
Vanguard’s Huver said: “The move from commission-based to fee-based advisors removed conflicts of interest in the US and we are starting to see that in Europe with RDR. We expect to see similar adoption trends in the retail segment in Europe as in the US.”
The Wall Street Journal has reported that in January inflows into European ETFs were a monthly record of $13.7bn, citing figures from BlackRock. The January flows were the equivalent of 22% of the total flows for last year. Equity funds had the largest inflows of $8.4bn after the European Central Bank announced a quantitative easing program.
The growth potential will attract new players but views differ on how the market will shake out.
Klein said: “There are 49 ETF providers in Europe but only 10 had an increase in net new assets last year, so there will likely be consolidation in the mid-term.”
Marinof said there will an increase in issuers in Europe as more investors use ETFs. “The market will attract new entrants which may have a multi-boutique structure or they may set up an ETF platform themselves which is hard to do,” he added. “However there are some existing issuers who will not reach the necessary scale and these two forces are fighting against each other.”
The American Football season culminates it two teams playing the Superbowl and one becoming the champion. It will be many seasons before the winners and losers in the European ETF landscape emerge and there may well be some last-minute surprises.
Featured image via D0llar Photo Club