Exchange traded funds (ETFs) are now such a mainstream investment tool that it is easy to forget that they are still equal to only 1.5 per cent of assets under management in mutual funds in Europe, and 4.5 per cent of those in the US. But inflows into ETFs continued to grow even during the worst phase of the crisis, with particularly big inflows into fixed interest and commodities, where their liquidity was highly prized.
Many wealth managers have conducted studies of their clients’ attitudes this year which largely concluded that while investors understood that the first half of the year would be a good time to re-enter the markets, they were nervous and looking for transparency, flexibility and simplicity – the very qualities that take an investor to an ETF.
Emerging markets
Investors flocked into cash last year but as appetite for risk returned, emerging markets were the first risk asset class to be added with strong inflows into Brazil, China and India. Here ETFs came into their own, as trading shares directly on local emerging market exchanges is often complicated by the need for foreign entity ID, while their futures markets are relatively illiquid.
That trend has started to slow with flows switching back to developed markets in anticipation of a rebound. European sector funds have also attracted strong inflows in recent months as investors used them tactically to long/short sectors on the back of adviser commentary, with particular focus on utilities and telecoms.
“We’ve seen more and more interest from the wealth management space over the last 12 months,” says Manooj Mistry, head of db x-trackers UK.
“Managers are looking at ways of making themselves more competitive or different and ETFs provide the building blocks they need. A number are looking at ETFs as a way of reducing costs and offering clients access to new markets, for example by putting 20-30 per cent of portfolios into passive and using the rest to go for value added strategies,” he explains.
“ETFs are a good way to cut costs, particularly standard funds covering developed markets such as the FTSE, Eurostoxx or Japanese market,” adds Mr Mistry.
Lower fees
ETFs will also be a major beneficiary of the Retail Distribution Review in the UK, which will eliminate product bias stemming from commission payments. In the emerging markets and alternative investment spaces, investors will probably remain prepared to pay for active management but ETFs could well become the vehicle of choice for most asset classes, as the average charge of less than 0.4 per cent will still be half of an active manager’s fee, even after the commission element is stripped out.
“There is a realisation that finally the game is changing, the rules are being rewritten, and that the Financial Services Authority is in the vanguard of rewriting those rules,” says Farley Thomas, global head of wholesale at HSBC global asset management.
“The abolition of commission in the UK will trigger a rethink of how wealth managers build portfolios, and many are anticipating this and changing the way they charge clients. It will change the way wealth managers look at active products because in one to two years active funds will be priced net of that portion of the annual management fee normally paid by the fund manager to the distributor or wealth manager. Will they continue to actively focus on managed products even where they don’t receive commission?”
The consultation period for the review has just finished and the current rules are likely to be phased out by 2011. Mr Thomas points out that in India commission was abolished this year within two months of a similar consultation. Like Y2K and Mifid, there is a need to plan well in advance of implementation.
“Today’s default setting is active management but in future the default setting will be indexation and advisers will need to justify it if they do anything different,” adds Mr Thomas. “It’s a potential seismic shift. Active managers will have to really demonstrate their skill, but as more of the world’s wealth is put in ETFs and similar products the dynamics of the market will shift and there will be greater opportunities for active managers.”
As the industry matures, greater distinction will be made between providers and funds. A wealth manager in Europe is faced with an overwhelming choice of 30,000 collective funds, compared for example with 8-10,000 in the US. This means they must find reasons to avoid mutual funds because they need to filter out so many quickly.
Currently there are probably no more than five to ten ETF choices for each index but as this market grows wealth managers will quickly become judgmental about firms they do and do not want to conduct business with, with a lot riding on the brand and strength of the provider.
