Joanne Young talks with industry experts about their outlook for the year ahead in the ETF market
Global ETF assets continued their steady march upwards throughout 2010, in a year characterised by extensive product diversification and innovation.
BlackRock’s year-end industry review put global ETF assets at $1,311bn, at the close of 2010, growing 26.6% over the year.
For Deutsche Bank ETF strategist Christos Constandinides, the success of ETFs over and above other types of funds characterises last year. “There are two main reasons why ETFs have fared well despite a tough year. The first is a trend for a back-to-basics approach. The second is that ETFs have developed to enable allocation decisions across asset classes and to provide specific opportunities within assets.”
BlackRock global head of ETF research and implementation strategy Deborah Fuhr anticipates a similar story this year. “I would expect growth figures of around 20% to 30% again. People will continue to invest in developed and emerging markets, as well as in dividend indices,” she said.
The number of individual products stood at 3,503 ETPs by the year’s end. With the latest BlackRock figures revealing plans for over a thousand additional ETFs already under way, the industry is well placed for healthy growth in 2011.
Consolidation on the cards?
While asset growth in 2011 seems assured, the continuing proliferation of products is a more complex issue.
iShares EMEA head of marketing David Bower said: “With over 1,000 funds domiciled in Europe now we might well see some consolidation within the industry.
“I expect to see new providers continuing to come to the marketplace in 2011 – this is a factor of the success of ETFs in capturing investors’ imagination. In the longer term though, I do think that scale and expertise play such a role in the provision of ETFs that there will be a sort of natural selection among products – although probably not in 2011.”
ETF Securities co-head of European sales Scott Thompson agrees. “The industry grew roughly 20% last year, and that is likely to continue,” he said. “At the same time, the industry does seem to be due for a period of consolidation.”
Deutsche Bank’s Constandinides said there is pressure among medium-sized providers, where the market looks crowded. “Housekeeping is going to generate pressure among providers this year.”
Already in 2011, boutique US ETF provider Grail Advisors has filed a letter of intent with the Securities and Exchange Commission (SEC) to sell its five remaining funds.
Constandinides said that the tendency for providers to come into the market on the back of very specific products is a trend he expects to continue. As for their longevity, iShares’ Bower remains sceptical about the continued delivery of niche investment strategies. Vanguard UK managing director Tom Rampulla is similarly unconvinced. He said: “Some of these products are just fads.”
An ETF by any other name
As ETFs grow in popularity and number, the structure of the industry is complicating.
Lyxor head of product development Lionel Phillips-Franjou said: “We’ve seen greater sophistication from clients coming to us with new requests; the market is developing and getting to a more mature stage.”
There is a danger, though, that ETFs lose the characteristic simplicity that drove their initial success.
BlackRock’s monthly industry report warns against a “new generation of ETFs” that deviate from a traditional structure. Fuhr said: “We’re looking at funds that don’t have indicative net asset values, or transparency, and do not offer in-kind creation/redemption. The market is being muddied by everything being called an ETF.”
New leveraged and inverse ETFs remain on hold in the US , while FSA chief executive Hector Sants warned against leveraged ETFs late last year. Bower at iShares repeats a common concern: “The challenge for synthetically replicated funds has been transparency”.
Providers are responding though. Credit Suisse started offering daily collateral disclosures on its synthetic ETFs in 2010 – a strategy subsequently adopted by iShares and db x-trackers.
However, Deutsche Bank’s Constandinides said: “Two years ago people were offering either physical or synthetic ETFs; now that dynamic is changing. Increasingly, the distinction is one of asset, rather than instrument, exposure.”
As firms step up their efforts to comply with the UK’s Retail Distribution Review (RDR) in 2012, ETF issuers are anticipating a bumper year. ETFs were cited by the FSA as one of the products advisers should become familiar with.
Vanguard’s Rampulla said: “The implementation of the RDR will help the ETF industry, as well as investors generally. The fee-based market should increase, which is good for investors. We’ve also seen in the US that the percentage of adviser-income coming from fee-based models is closely correlated to the uptake in ETFs.”
Providers still have a lot to do. ETF Securities’ Thompson explained: “Financial advisers and retail investors are still at the very early stages of understanding these products; we really are starting from the point of how ETFs work.”
One thing the industry is unanimous on is the need for an information drive.
Thompson said: “2011 is the year of education, education, education. The industry cannot afford to sit back and assume that the introduction of the RDR will automatically lead to increased investment in ETFs.”
Rampulla is similarly vehement. He said: “There still has to be a huge amount of education around ETFs, and this has to come from within the industry. You get a better result from free enterprise anyway; this should be a competitive issue.”
Constandinides at Deutsche Bank said: “2010 has been the year of sectors, both in terms of greater depth and of product coverage.”
Phillips-Franjou said Lyxor has expanded its own sector offering on the back of significant interest from investors and he expects interest to grow further in 2011.
Gold ETFs have dominated headlines and Constandinides said their popularity is more than a passing trend. “Even when market conditions eased and picked up, inflows slowed down but there were still no outflows,” he said. “This could be explained by the feeling that we’re still experiencing choppy markets.”
With experts anticipating volatility as an enduring economic trend, the boom in gold ETFs looks to be a story that may run in to 2011.
ETF Securities’ Thompson says the success of gold ETFs demonstrates a demand for physically-backed products that is likely to continue through 2011. “However, it’s difficult to see where you go next in this space. I wouldn’t expect a sudden raft of new physically-backed products.”
However, Phillips-Franjou emphasised that the commodities class is developing as a whole. He said: “Investor interest is broad and diversifying, not only in gold, and I expect to see more subclasses covered in the year ahead.”
iShares’ plans would appear to confirm this. Bower revealed that of the 20 to 30 new funds the company expects to launch in 2011, one area they will be looking to expand in is the commodity asset class. He added: “There are also gaps in the high yield market.”
Emerging market ETFs was another headline success story in 2010, where assets grew 45.6% up to the end of the year, according to BlackRock. Vanguard’s Tom Rampulla strikes a warning note about the popularity of these products in 2011. “I think people should start being cautious about emerging markets. We should remember that a lot of money went into bonds, but then came out again.”
For Phillips-Franjou though, the emerging markets story is just beginning. He highlighted the particular success of single country exposures. “Our Turkey ETF, for example, grew 130% over the past year. When you have a market that develops in maturity, you can expect investors to look for granularity in investment options.”
With the industry maturing, this demand for honed strategies features prominently in providers’ plans for 2011.
Phillips-Franjou said fixed income products are likely to see further growth. “We will be launching a euro high yield product soon in addition to a dollar-denominated emerging market sovereign debt ETF.”
ETF Securities’ Thompson said currency ETFs should grow in profile this year. “Currency wars are likely to continue through 2011, as investors have struggled to get proper access to this asset class. If next year has similar themes but with a slightly more robust economic recovery, we will be looking to develop our Forex platform.”
This sort of exposure is seen as being targeted, instead of niche. iShares’ Bower said: “Basically, what I expect to see in terms of product development is greater precision within core asset classes.”
US providers enter Europe
US ETF issuer Vanguard is preparing its move into the European market in 2011, while State Street has indicated its intention to enhance its presence this side of the Atlantic.
Both companies have size, as well as the advantage of extensive experience in providing ETFs. With HSBC also looking to expand its ETF platform, there is likely to be competition at the top during 2011.
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