ETFs have eclipsed index mutual funds in the US and are on track to do so in Europe, yet platforms’ functionality and costs mean advisers aren’t yet jumping on the trend with the same enthusiasm as other professional investors.
ETFs surpassed tracker funds for inflows in 2014 and have continued to attract more assets in the period since, according to Cerulli analysis. In 2017, index trackers took in €77.9bn across Europe compared to €87.3bn drawn in by ETFs. In August 2018, index trackers represented 53% of the passive universe compared to 47% in ETFs.
In the US, ETFs already account for 50.4% of AUM, totalling $3.3trn, according to Morningstar data.
European passive funds total net assets 2014-2018
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Yet, few advisers would directly recommend an ETF or include them within advisory models, says Platforum analyst Andrew Ashwood. “ETF transaction fees on adviser platforms unanimously cost either more or the same as mutual fund trades and these additional charges levied on a client’s portfolio can pose a significant barrier to adviser adoption of ETFs.”
Advisers versus DFMs
When it comes to other intermediaries, Cerulli says private banks employ the products to achieve a determined exposure to international markets and wealth managers to construct model portfolios with core exposure to specific markets or asset classes. Robo-advisers are also forecast to be a rising source of flows with the European ETF industry growing 61% in 2017. Cerulli forecasts AUM could reach €31.8bn by 2022.
Most advisers aren’t looking to conduct such tactical switches in portfolios and are satisfied with using the daily dealing point of funds come the time for a quarterly rebalance, says Ashwood, noting intra-day pricing is more of a benefit for DFMs.
Discus director Gillian Hepburn was surprised at the numbers of advisers who attended the recent Inside ETFs conference in London, but agrees they generally prefer index funds, particularly for model portfolios on platform. “Consideration needs to be given to custody and trading charges for ETFs and the mechanics of different settlement times if combining ETFs and funds within portfolios,” Hepburn says.
However, Rathbones multi-asset portfolio manager David Coombs uses passives for tactical calls. “We therefore prefer ETFs, which allow for intra-day trading, and which helps us to manage portfolio risk quickly and appropriately.”
EQ Investors uses index funds for model portfolios and ETFs for some of its bespoke portfolios in both core and satellite positions, says head of investing Sophie Kennedy. “We are typically more comfortable holding larger passive exposure during macro risk-on environments and when intra-stock correlations are high, whereas we would be more wary during periods where the market is being whipsawed by macro events.”
ETFs found critic in Bogle
The late Jack Bogle, who was last week remembered as an investor who had done more for the individual saver than Warren Buffett, had long been an ETF critic despite being the founding father of passive investing.
In December 2016, he wrote in the Financial Times that while individual investors were the largest holders of Vanguard “traditional index funds”, banks and financial intermediaries hold almost 90 per cent of the SPDR S&P 500, the first ETF. Turnover in the former was 8% in the former and 3,000% in the latter, he said.
In Europe, Vanguard holds $40bn in ETFs and $130bn in index tracking funds with an agnostic approach to the two products. Globally, those figures are $4.3trn in mutual funds and $990b in ETFs.
7IM senior investment manager Peter Sleep, who focuses on passive portfolios, says he is agnostic but uses far more index funds than ETFs. “I do not believe that ETFs turn private individuals into trading dervishes and the traditional index funds turn private individuals into long term investors.” Although Sleep says an investor who wants to speculate might naturally gravitate to ETFs.
Granularity of ETFs
Speaking to Portfolio Adviser in December, Vanguard UK ETF specialist Liz Wright said: “Where we’re getting a lot more of the ETF investment is the wealth managers, discretionary fund managers, investment managers in asset management houses, that need the granularity, number one, and number two and need the opportunity to make tactical calls.
“It could potentially be something like a three, six, nine-month call they want to do and tactically an ETF is much better for them.”
ETFs offer more granular exposure, she said. “For example, we have a 1-3 USD Bond ETF. We don’t have that in an index fund, we just have a USD corporate bond fund so you don’t have that duration granularity.”
Transparency on execution and portfolios are among the benefits of ETFs, Franklin Templeton Investments head of ETF sales for Emea Caroline Baron tells Portfolio Adviser. Additionally, all fees are “externalised” in that existing shareholders of ETFs do not bear the costs of any new entrants. The asset manager offers nine ETFs to European investors and no index funds.
Volatility fails to shake ETF inflows
Lyxor head of ETF strategy for Northern Europe Adam Laird says European investors are using ETFs as long-term, low-cost products, matching Bogle’s philosophy.
“Trading volumes do not generally spike in times of volatility, like in the last few months and the last year,” Laird says, adding: “I think it’s undervalued that at times when markets are falling, people don’t want to pay extra fees on the money they have.”
In December 2018, ETFs across Europe took in €2.3bn taking total assets under management to €633.1bn, according to Lipper data.