February 17, 2009
The exchange traded funds (ETF) sector belongs to the few asset management segments that did not only withstand the current financial market turmoil but even reported solid growth rates last year. While the MSCI Europe declined by roughly 48% in 2008, ETF assets in Europe surged by around 24.3% to EUR 112.9 bn in 2008 (EUR 90.8 in 2007). What are the main driving forces behind this development?
Recent market developments
Last year, the ETF sector reported significant inflows of EUR 52.4 bn while all other fund types in Europe suffered aggregated outflows of EUR 357.4 bn. This trend even allowed offsetting negative valuation effects from equity markets with the MSCI Europe down by 48.2% in 2008 and enabling the European ETF sector to report an increase in AuM of EUR 22.1 bn in 2008.
ETFs benefited from an increasing number of both institutional and retail investors who started to reorganise their asset allocation and to favour transparent and simple investment products rather than more complex investment instruments such as structured products, derivatives, active funds and partly hedge funds. In this vein, the high flexibility and liquidity of ETFs that range from fixed-income investment strategies, money market investment, short-indices to credit market exposure paid off. Notably money market ETFs enjoyed superior growth dynamics. With regard to structural trends, a steadily increasing number of active fund managers turned to index funds as they allow, on the one hand, cost-savings and, on the other, implementing core-satellite strategies in a cost-efficient manner. By following this approach, ETFs are used as core and provide active managers with low cost beta, i.e. the market rate of return. Simultaneously, active managers also used different satellites that constitute actively managed investment approaches aiming at delivering alpha, i.e. outperformance against a specific benchmark. Experts estimate that by controlling part of their equity position with passive instruments, active fund managers can reduce their costs by about 25% in the ideal case without affecting performance. Lastly, funds of funds were another important source of growth for the ETF industry as ETFs constitute a cost-efficient investment instrument that is flexible enough to be included in various types of fund of funds approaches.
We expect the growth trend to continue in the medium term despite persistently volatile capital markets during 2009. We consider it plausible that assets under management in the European ETF market will grow to around EUR 150 bn by the end of 2010. This will be driven by structural changes on both the supply and the investor side. On the supply side, the strong growth in the use of swaps for index replication will lead to further product innovations especially in the fixed-income segment and thus further broaden the present spectrum of investment products. On the investor side, institutional investors have not yet tapped the potential of ETFs to the full. More institutional investors will turn to ETFs as they are easy to trade and manage, especially compared to derivatives, and active fund managers will make stronger use of ETFs as investment instruments in order to reduce the cost of active portfolio management. Furthermore, pension funds will invest more in ETFs. It is estimated that at the end of 2006 pension funds assets amounted to close to USD 23 trn. If just 1% of these assets was switched into ETFs in the medium term, the global ETF market would expand by one-fourth.
See also report “Exchange traded funds: Further sophistication fuels investor demand”
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