Paul Burgin analyses the Italian ETF market to discover an appetite for trading and high interest among retail
Italian investors are keen traders of ETFs. Assets under management (AUM) make Italy a top 10 European market, but trading volumes place it in pole position. The market also has some interesting characteristics when it comes to product origin, design and usage.
BlackRock’s ETF Landscape Industry Review shows Italy as the fifth largest ETF market in Europe for AUM. It has assets of $1.7bn, placing it behind Sweden and ahead of Spain in the European rankings.
When it comes to listings, Italy is second only to Germany for the number of ETF products available. Borsa Italiana said there are currently 447 ETFs and 67 exchange-traded commodities (ETCs) listed on the regulated market ETFplus, a range equal to that available on the Paris exchange.
Yet very few of the ETFs open to investors are primary listings as the country has no domestic issuers. The Italians have one of the biggest selections of secondary-listed products, all of which are operated by providers without an Italian background or local parent bank.
Pietro Poletto, head of ETFs and ETCs for the London Stock Exchange Group, the owner of Borsa Italiana, said: “All 11 of our ETF providers are foreign issuers who tend to launch products on their domestic market before cross-listing them on Borsa Italiana shortly afterwards. From our experience, investors are more concerned with the transparency and quality of the product offered rather than whether it is domestic or not.”
The cross-border nature of the Italian market needs further explanation. The openness displayed by investors to non-Italian ETFs can be traced back to other products, particularly mutual funds. Law and taxation have played a big part in creating one of Europe’s most open markets to international players.
The Italian mutual fund market went through dramatic change when the European Union’s Markets in Financial Instruments Directive (Mifid) was applied to local law in 2007. The government and Italian financial services regulator Consob developed one of the strictest interpretations, effectively banning all commissions and hidden fees. If Italian investors wanted to buy funds, and banks and advisers wanted to sell them, then the cost of advice had to be separated.
The effect was immediate. Investors returned to their beloved segregated accounts, reluctantly paying for advice along the way. The Gestoni Patrimoniali di Fondi (GPF) segregated account structure can be a more complex and costly way to organise client portfolios but offers a high level of tailoring.
Locally domiciled funds also suffer a tax disadvantage. Investor gains are taxed every year at 12.5%, while those on cross-border funds usually domiciled in Luxembourg are only taxed on redemption. Not surprisingly, a huge number of local and international groups now offer funds domiciled outside of Italy.
Poletto said the tax regime for calculating capital gains applied to ETFs is also complicated, for investors to understand and for back offices to manage. The industry would like to see simplification.
The Mifid review may also provoke change in the market. The Committee of European Securities Regulators (Cesr) recently proposed extending the directive’s transparency requirements to equity-like instruments, including ETFs. Poletto said: “Depending on how this were implemented for both pre and post-trade visibility, this would allow market participants to have a better understanding of the availability and volumes of trading, including over-the-counter volumes.”
Domestic market growth
In the meantime, ETF issues, AUM and trading volumes continue to rise. 111 new ETFs have been listed so far this year. New players in the market include ETF Securities, Credit Suisse, Amundi and UBS. Borsa Italiana expects to hit a total of 500 listings in 2011.
New products included country specific issues from PowerShares, tracking the FTSE RAFI Hong Kong China index, and db x-trackers, providing exposure to Canada and Mexico. ETF Securities launched a double leveraged ETF and a short strategy. Amundi busied itself with a suite of structured short fixed income vehicles and traditional commodity products.
Credit Suisse also widened its range with 13 secondary-listed cash replication vehicles, taking the total it offers on the Borsa Italiana to 30.
The number of ETF trades on the Italian exchange this year has rocketed by over 60% compared with 2009. Borsa Italiana says two million took place in the first seven months of the year, with a value of €46.5bn.
The Italian market is unique in Europe for the composition of its investor base. Poletto said over half of all trades are worth €100,000 or more, demonstrating strong institutional demand. The rest are worth €5,000 or less, an indication of how strongly retail investors have taken to ETFs.
That makes the market far more retail-orientated than others in Europe. While other smaller retail markets concentrate on traditional ETFs, Italians have been big buyers of structured ETFs, mostly those giving leveraged or short exposure to the Italian equity market via FTSE MIB trackers.
The Xbear FTSE MIB fund and Lyxor ETF Leveraged FTSE MIB had a combined turnover of €9.5bn in the first seven months of 2010, exceeding the combined total for the next eight biggest ETF turnovers.
Alan Rambaldini, ETF analyst at Morningstar, said: “There are some crazy things going on in the Italian market. There is a culture of taking care of your own investment decisions. The top traded funds are leveraged ETFs, usually short inverse MIB and leveraged MIB.”
The acquisition of Borsa Italiana by the London Stock Exchange in 2007 had an important effect on the development of Italy’s ETF market. It also gave foreign firms plenty of motivation to cross-list London products in Milan. Rambaldini said: “There are a lot more foreign asset managers and foreign domiciled funds. They benefit from economies of scale by offering different asset classes in different countries.”
Aside from leveraged and short products based on local indices, Rambaldini said there is plenty of demand for products with a more international flavour. He said the top 10 trades also include the S&P 500, physical gold, leveraged DAX, India and crude oil exchange-traded products. He added: “Investors are certainly open to ideas and the market players are open to product development.”
Italian investors are comfortable with overseas providers and investing in ETFs listed on other exchanges. Emanuele Bellingeri, head of sales at iShares in Italy, said: “There are plenty of clients buying in other markets such as the LSE and Deutsche Boerse. Nevertheless, Borsa Italiana is a top three exchange in Europe in volume terms. In terms of the number of contracts, it is number one.”
Bellingeri believes ETF investors are particularly active in Italy because client usage of self-invested investment wrappers is widespread. That has shifted attention away from segregated GPFs, which only allow for mutual fund holdings, towards Gestioni Patrimoniali Mobiliari (GPM) structures enabling investors to hold a wider range of products. Bellingeri says: “We have seen outflows for GPF in the last couple of years. Investors are moving to GPM which allows them to hold single stocks, mutual funds and other listed products.”
Institutional investors and fund managers are also getting in on the game. Bellingeri said secondary market volumes indicate their usage of ETFs is rising.
However, local banks could miss out as ETF interest surges. Bellingeri said the biggest local banks such as UniCredit took the decision five to six years ago not to develop their own product ranges. Nevertheless, UniCredit is a significant player in the ETF industry, as market maker for ETFs issued by all asset managers and asset classes, listed on exchanges across Europe.
Competition between market players remains high. The Italian market is one of scale where providers need to attract large quantities of assets and develop trading volumes to remain profitable.
Bellingeri said that leveraged and short products make up around 40% of market volumes, but their share of assets is far lower. Non-leveraged straight products that track the S&P 500, Eurostoxx indices and emerging market equities have larger AUMs in the equity asset class. European corporate bond products are also gaining in popularity at the expense of gilts and other government-issue trackers.
The top iShares ETFs by AUM are European Corporate Bonds, S&P 500, Eurostoxx 50, MSCI Japan, MSCI Emerging Markets, China and European Government Bonds.
The complexity of the highly traded products could be an issue. Bellingeri suspects that not all investors realise the full implications of the leveraged and short products they buy. He said: “When a product promises a double or inverse return, not all private investors fully understand.”
Investors may like more complex products, but they appear more traditional when it comes to replication. Institutional investor usage of cash-based ETFs is growing. Around half of iShares’ institutional holdings are now cash-based, said Bellingeri.
He added: “Three years ago, it did not matter to investors how funds replicated indices. Now they understand the risks and want to compare different products. If cash-based is available, they will always prefer it. But they will use swap-based ETFs if cash options are not available.”
Client education is therefore a necessity if the market is to mature. Still, Bellingeri sees plenty of potential as client bases are generally stable. Unlike mutual funds, flows and assets are less adversely affected by external shocks such as the financial crisis.
Borsa Italiana is confident about the prospects for the Italian ETF market. Product transparency was enhanced during the financial downturn and investor numbers continue to grow. The development of the independent advice sector is also contributing to greater ETF usage.
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