Tue, 01/09/2015 - 13:15
Boutique asset managers favour ETFs was one of the findings of a recent survey conducted by research firm TABB Group for software company SunGard. Some 48 per cent saw ETFs as an area of significant demand from investors, with many boutique managers using ETFs as a low cost way of investing in an asset class and bolstering performance through stock picking and direct investment.
Commenting on the research, Trevor Headley, head of product management of SunGard's boutique asset management business, says that ETFs are increasingly being used as by this group as an efficient base for focused portfolio construction.
Wealth and asset managers in the UK are increasingly using ETFs for their clients portfolios and the direct result can be found in the news that ETF assets have overtaken hedge fund assets.
The second quarter of 2015 saw ETFGI reporting that there was USD2.971 trillion invested in the 5,823 ETFs/ETPs listed globally at the end of Q2 2015, while hedge fund assets over the same period stood at USD2.969 trillion, invested in 8,497 hedge funds according to Hedge Fund Research.
The two industries have been locked into a step-by-step competition for greater assets within the alternative sector since ETFs arrived on the scene, over 20 years ago, but in fact the two market segments have little in common.
An ETF, or exchange traded fund, is a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund. However, unlike a fund, an ETF trades like a common stock on a stock exchange, with prices rising and falling as the market moves throughout the trading day.
ETFs have become increasingly sophisticated in recent years, evolving into a wider range of underlying markets and into more tactical vehicles, allowing investors to select their exposures through applications of smart beta, currency hedging or short and leveraged options.
French ETF issuer Lyxor defines smart beta ETFs as denoting rules-based investment strategies that do not rely on market capitalisation.
Lyxor uses three sub-segments to classify all the products that are included in this category. Risk-based strategies based on volatilities and other quantitative methods; fundamental strategies based on the economic footprint of a firm or state – through accounting ratios or macro-economic measures, respectively and lastly, factor strategies, which include homogeneous ranges of single-factor products and multifactor products designed specifically for factor allocation.
The US dominates the ETF industry with some USD2 trillion in assets, roughly 75 per cent of the market against Europe which has close to 15 per cent.
ETFs in the US are stronger in the retail sector than they are in Europe. In the US, ETF ownership is split roughly into two parts, 50 per cent institutional and 50 per cent retail. In the UK and across Europe the figures are 85 per cent institutional and 15 per cent retail, as private investors have been slower to buy ETFs, a situation that is clearly changing.
Observers and practitioners in the industry believe those European figures are set to balance up, as sophisticated investors and wealth managers increasingly use ETFs for sector exposure and tactical purposes in their client portfolios.
One of the key providers of ETFs in Europe, Source, published research earlier this year which revealed that more than two-thirds (68 per cent) of professional investors and advisers in Europe are currently using ETFs in the portfolios they manage, while 22 per cent have used them in the past.
The survey was conducted among more than 750 professional investors and advisers based in 11 European countries. Each of those interviewed were responsible for at least GBP50 million worth of private client investments or GBP100 million of institutional assets. The biggest users among wealth managers, according to the study, are in Switzerland, while the smallest take-up is in Spain.
It has been the UK's love of an active portfolio manager that has held back the development of ETFs in the country, but new ETF products and an increasing disenchantment with the performance and fee structures of traditional active funds are pushing ETF growth.
Jordan Sriharan, investment analyst, with GBP2.9 billion Thomas Miller Investment is at the sharp end of creating portfolios and selecting ETFs. Thomas Miller Investment's Managed Portfolio Service manages GBP400m in multi-asset portfolios for private clients managed through model portfolios which are constructed using long term asset allocations. The four model portfolios have been designed to achieve performance targets of cash plus 2 per cent, 3 per cent, 4 per cent and 5 per cent on a net of fees basis.
"Where we do use ETFs, we typically utilise them in asset classes where market information is most transparent and, consequently, the pricing of the underlying holdings is extremely efficient," Sriharan says.
"By and large we use ETFs in the equity space. We use them considerably less in fixed income because of the issues around benchmark construction in the asset class. In alternatives, such as commodities and hedge funds, we use active managers because the space is more complex and requires more detailed fund selection."
There is also a geographical aspect to the firm's use of ETFs. Sriharan explains: "We tend to use equity ETFs in developed markets rather than emerging markets because emerging markets are more opaque and are prone to suffering more idiosyncratic bouts of risk aversion. We require active managers for that because they are, typically, on the ground and understand their markets well, helping them to navigate the space more successfully. Developed markets equities have a larger and more developed investor base which leads to more efficient price discovery, so buying the indices can work for us."
Sriharan's approach is not cut and dried and can be moulded to fit certain situations. "It's not a one way street because some developed equity markets have nuances, such as the FTSE 100 which is dominated by oil and gas and financial companies. These sector biases can slant a portfolio exposure so we would try and use both ETFs and an active manager or managers in the UK."
Smart beta ETFs, designed to offer a particular exposure are also employed by the firm.
"We would use smart beta ETFs if we were trying to build a deliberate exposure within an asset class. We have looked at them and will look at them again going forward but we have, historically, tended to focus on traditional asset allocation. We manage within the constraints of our long term asset allocation benchmarks so we are mindful of taking significant off-benchmark risk," Sriharan explains.
The ETF live price feed advantage doesn't always work so well for wealth managers who need to use a single price to reflect consistency across discretionary and managed portfolios. In this instance, tracker funds might prove the more popular route to index and benchmark exposure.
Pan Asset, a division of Charles Stanley Group, is a specialist passive product provider which looks at the whole of the European passive product market and selects a list of products for their internal wealth managers across global asset classes based on a number of factors. They also offer a facility for external wealth managers.
Lynn Hutchinson, associate director, explains that the factors include, among others, tracking difference vs underlying index, cost, transparency of product and provider information.
"As there are an increasing number of products available from the providers, with many of them having the same objective to track the same index, there is a `preferred' list of available ETFs that is available within the Group," she explains. "This list is not static and will update with new products or changes from existing products, it does not mean that Pan Asset suggests selling the current product that they may hold but does make available any new products to new investments within portfolios."
The Pan Asset list tends towards London Stock Exchange-listed products, primarily GBP class where available, because of the predominately UK based client portfolios, but Pan Asset also encourages investment managers to call the Pan Asset team to discuss products that they may be looking for that are not yet in the list.
Hutchinson explains that additionally, the list does not dictate what an investment manager can or can't buy but is a guide to what is available. For non-sterling based client portfolios the investment managers are aware that there are different currency classes available within a lot of the ETFs.
"External wealth managers are able to access our expertise in this area via model portfolios where we combine best of active asset allocation with best of passive implementation," she says.
Pan Asset reports that the most popular ETFs with British wealth managers this year have proved to be GBP currency-hedged ETFs, particularly in Japan and Europe, probably driven by rising FX volatility.
Hutchinson says: "Within these products, currency exposure of the underlying equities is typically hedged by buying forward contracts and rolling them over monthly however there may still be some small currency exposure if the currency fluctuates during the month (contracts between the rolling one month contract are adjusted for money going in/out but not for currency fluctuation during the period)."
The firm also notes that dividend-focused ETFs are also becoming more popular as investors look for a way of increasing the yield within the portfolios.
Hutchinson also comments that for external wealth managers using platforms, there are still some issues with trading costs for ETFs depending on the platform that they use – although, she comments, a lot of ETF providers are in discussions with platforms to try to reduce this problem. "Most ETF providers are continuing their ETF education programme with wealth managers which is helpful but more education on platforms would be an added bonus for advisers when making a selection on which product to use and what product might be suitable for their clients," she concludes.
In that very vein, of continuing education, three of the leading UK issuers got together earlier this year in an industry initiative to promote the greater safety of short and leveraged ETFs compared with spread betting.
The initiative in March was jump started by The Independent newspaper who ran a story of how the Swiss National Bank's January move to scrap its ceiling against the Euro impacted on spread betters, with a pianist's GBP2 bet ultimately costing him GBP5,500 and a teacher, on GBP18,000 a year, ending up with a close to GBP280,000 debt.
Three leading ETP providers, Société Générale, ETF Securities and WisdomTree's Boost joined up to speak to wealth managers and sophisticated investors on the benefits of Short & Leveraged Exchange Traded Products at the London Stock Exchange. Société Générale's director of Listed Products and Lyxor ETF, Ben Thompson explained that this could never happen with ETFs because investors in ETFs never risk more than their original investment.
Hector McNeil, co-CEO, WisdomTree Europe says: "Leveraged ETPs are the next generation of leveraged trading. OTC leveraged products are doomed to disappear over time."
Townsend Lansing, executive director and head of Short & Leveraged Platform for ETF Securities opened the session at the LSE explaining that there are 880 products available with about USD60 billion in assets under management globally in Short & Leveraged ETPs, spread across commodities, equities, foreign exchange and debt.
Equities lead the way in terms of assets under management and use is growing with currently the products seeing some USD637m in flows, year-to-date, in Europe.
The experience of the three firms was that wealth managers and sophisticated investors are using Short & Leveraged ETPS to trade high conviction views more regularly in the current high-volatility market environment.
The products allow investors to run a leveraged long or short position from within an exchange environment. The leverage is on the daily performance and resets every day which reduces any loss on a daily basis, plus there is an `airbag' mechanism designed to prevent losses in extreme market conditions.
Asked at the event if the products are retail or institutional, Lansing said that they worked for a wide range of investors who don't have access to futures, while McNeil described them as `derivatives light'. Thompson says: "You are not trading in a black box and you are trading with the house."
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