Traditional managers move to ETF market 23 February 2016

Traditional managers move to ETF market

The ETF sphere is expanding. More than 40 companies around the world listed their first ETFs in 2015. Increasingly, the old guard of asset managers are moving into the space: Legg Mason, Franklin Templeton and Goldman Sachs have been adding ETFs to their product suites.

The rapid spread of ETFs is seen as an opportunity for traditional asset managers. Last year set a record for ETF inflows, despite global volatility. Across Europe, ETF assets rose by a quarter to more than £350bn. The popularity of passive is putting a strain on flows into traditional funds and, for many groups, launching ETFs is an obvious response.

Smart challengers

It is unlikely that any new entrant will challenge the incumbents for the traditional indices. Mainstream ETFs, tracking simple indices such as the FTSE 100 or S&P 500, still command the lion’s share of assets but the space is crowded and charges have been driven low.

Rather, the new entrants are building innovative ‘smart beta’ ETFs to differentiate themselves. An asset manager can differentiate itself by creating a strategy in partnership with an index firm, such as the FTSE or MSCI. If you are known for global growth funds, why not start a global growth index ETF? Take BMO Global Asset Management, which launched its first ETFs in October. They track equity indices created with MSCI indices to focus on high-yielding shares in Europe, UK or the US. The ongoing charge of 0.35 per cent is higher than a standard ETF but much lower than an active equity index fund.

Active ETFs

In some areas even smart beta is becoming crowded. Investors can choose from six European low-volatility equity ETFs – almost as many as track the Euro Stoxx 50 index. Active ETFs are not new but they are not common. Pimco is the most successful manager; its short duration bond strategies, such as the $1.3bn (£900m) Pimco US Dollar Short Maturity Source Ucits ETF, have been popular.

Only a few dozen active ETFs are available in the UK (compared with more than 1,000 index tracking ETFs), and their number is shrinking. Around a fifth of Europe’s active ETFs wound up in 2015, including the db x-tracker ETF managed by wealth manager SCM.

In December, Vanguard surprised many in the industry by listing four actively managed ETFs. These global equity funds use a quantitative strategy to select stocks based on volatility, momentum, value or (low) liquidity. Eschewing an index frees Vanguard from the bind of the index rules and removes the index costs. You would be forgiven for calling these ‘smart beta’.

Active ETFs represent a fundamental shift for a group that has to date focused on passive investing. But this is an interesting test case for the industry.

New opportunities

New active fund launches are a good opportunity for investors. Research shows that younger, smaller funds tend to outperform. A new fund can give an active manager the chance to start again – free from past mistakes.

However, investors should be discerning. Young ETFs can be illiquid and need time to prove their merits. The outperformance of the past might not be repeatable. Some strategies, such as buyback equity focused ETFs, struggled in last year’s volatility.

Looking ahead, ETF product development teams are already hard at work for giants like Aberdeen and Schroders. The challenge for competitors will be to raise assets quickly enough to become viable. The market is still concentrated – four ETF issuers account for over three-quarters of the market. But the opportunity is there for a firm with the right strategy and budget. And I for one will rule nothing out.