FINANCIAL TIMES Monday 2 February 2015 FTfm | 9

At war over priceHow much lowercan charges go?

PAGE 11fm Exchange Traded Funds

PAUL AMERY

A fter another record yearfor asset gathering, ETFproviders have set theirsights on the globalderivativesmarket.

The global exchange-listed futuresmarket totals $30tn in exposures,while derivatives traded off-exchange have a total notional valueof nearly $700tn, according to theBankfor InternationalSettlements.

Meanwhile, assets in global ex-change traded products hit a recordof$2.8tnat theendof2014,accordingto consultancy ETFGI, having wonmore than $330bn in assets over theyear — far smaller than the marketfor derivatives but typically fullyfunded at the outset, unlike highlyleveragedderivativescontracts.

But what is interesting to manyobservers is the growing interest inETFs from participants who previ-ously only looked at derivatives.There is common ground betweenETFs, futures and swaps. Many ofthese financialproductsreferencetheperformance of indices and bench-marks. And, say market observers,ETFs have recently become particu-larly competitive with the $4tnmarket forequityderivatives.

“I wouldn’t be surprised if in 2015switches from futures and forwardshelped asset flows into ETFs to hitanother record,” says ThorstenMichalik, head of the global clientgroup, passive, at Deutsche Asset &WealthManagement.

According to fund providers, a keyreason for ETFs’ enhanced attractive-ness is the tightening regulation ofbanks.

New constraints on the size and

make-up of their balance sheets, andthe incoming Basel III rules for liquid-ity management, are raising banks’cost of capital. As banks have histori-cally dictated the pricing of deriva-tives, this cost is being passed to thepurchasersof futuresandforwards.

Chanchal Samadder, head of UKsales at Lyxor ETF, says: “In the past,many investors assumed futureswere free because, unlike ETFs, theydon’t carry an explicit management

fee. Futures look transparent . . . Buttheir pricing is complex and theycarryhiddencosts.”

According to ETF issuer Black-Rock, the annualised cost of main-taining a long position via futurescontracts on three leading equityindices, the S&P 500, the Euro Stoxx50 and the FTSE 100, ranged from 0.9per cent to 1.4 per cent in the latestquarterly futures “roll”, held inDecember. Meanwhile, says Black-

Rock, ETFs are becoming more effi-cientandcheapertoaccess.

For leading indices, “the costs offutures and ETFs have now crossed”,says Rachel Lord, European head ofBlackRock’s iSharesunit.

Ms Lord says that iShares has iden-tified US$5.5bn of recent switchesfrom futures into its ETFs, reflectinggrowing client awareness of thechange inmarketpricing.

BlackRock points out that inDecember 2014, assets in ETFs track-ing the S&P 500 index surpassed theopen interest in S&P 500 futures con-tracts for thefirst time.

However, according to a represent-

ative of the Chicago Mercantile Ex-change (CME), some recent asser-tions about the cost superiority ofETFsneedqualifying.

Matt Tagliani, executive directorfor equity products at CME Group,says: “It’s incorrect to say ETFs havebecome cheaper than futures . . . Theargument is only valid for passive,unleveraged US investors using along-term,buyandholdstrategy.”

For some investors, however, theincreasing competition betweenETFs and futures sounds like goodnews. But it also means extra home-workfor those involved.

“The most efficient way to createindex exposure depends on a client’sdomicile, tax status, objectives andholding period,” says Mr Tagliani.“Youneedtodoyourownanalysis.”

ETFgiants bet on futures for flowsBanks’ increasing costs are making ETFs more attractive to derivatives buyers

‘Many investors assumedfutures were free, becausethey don’t have anexplicitmanagement fee’

Upward trend: for some, thecompetition between ETFs andderivatives sounds like good newsJason Alden/Bloomberg

10 | FTfm FINANCIAL TIMES Monday 2 February 2015

ATTRACTA MOONEY

BlackRock’s iShares has had a firmhold on the top position in Europe’sexchange traded fund market foryears, boasting ETF assets three tofour times larger than its nearestrivals. But new figures show the fundhouse struggling to gain ground in therapidly growing European market, instarkcontrast to itscompetitors.

Last year, although a record-break-ing $60.5bn flowed into European-domiciled ETFs, iShares portion ofthat total declined to about a third at$20.3bn.

In 2013, its net inflows were also$20.3bn but this amounted to about80 per cent of the total of $25.7bnwhich flowed into European ETFs. As

a result, iShares has lost marketshare. By the end of 2014, it managed48.4 per cent of Europe’s ETF assets,down from 50.8 per cent in 2013, saysETFGI,aresearchcompany.

Although the drop of 2.4 percent-age points might seem small, espe-cially as iShares easily retains its posi-tion as Europe’s leading ETF pro-vider, the decline is indicative of thechallenge iShares faces — and theopportunities available to other fundproviders.

“Competition among EuropeanETF providers is intensifying,” saysHortense Bioy, director of passivefund research at Morningstar.“[iShares is] losing market share andif it weren’t for its acquisition ofCredit Suisse’s ETF business [in 2013]it would have lower market sharetoday.

“Groups such as Vanguard, UBS,Source and Amundi have all gainedmarket share at iShares’ expense.”

Detlef Glow, head of research forEmea at Lipper, says BlackRock’s gripis being challenged by a combinationof new entrants, product innovation,fee price wars fees, and changes toreplicationstyles.

BlackRock is also facing a “concen-tration issue” — investors feel theyalready hold a huge chunk of its prod-

ucts, says Nizam Hamid, an ETF andhedgefundconsultant.

Deborah Fuhr, managing partnerof ETFGI, agrees: “Many investorsneed to diversify the product provid-ers theyworkwith.”

AndMrGlowaddsthat there isnowan opportunity for other providers totakemarketshare.

iShares, meanwhile, appearsunconcerned about the increasingcompetition. Rachel Lord, head ofiShares Emea, says: “iShares’ pri-mary aspiration is to be the leader inflows and we’ve cemented that topspot in Europe over the past fewyears.”

The company says it “welcomes”competition, but the question is howbig its decline inmarketsharewillbe.“There are seven or eight pretty

strong players at the moment allcompeting for assets,” says MichaelJohn Lytle, chief development officeratETFproviderSource.

Ms Bioy says iShares is likely toremain a dominant player in Europejust as it is in the US, where it controlsthe bulk of assets with Vanguard andState Street. However, she adds: “AstheETFmarketgrows, I think iShareswill continueto losemarketshare.”

Even if iShares retains dominance,when it comes to the European ETFspace, Mr Glow says: “Competitionwillgetevenmore intense.”

Headwinds: iShares is facing increasing competition —Eric Risberg/AP

EUROPE

The fund house isstruggling to stay ahead ina rapidly growing market

iShares fightsfor fund flows

‘There are seven or eightpretty strong players atthemoment, allcompeting for assets’

Exchange Traded Funds

FINANCIAL TIMES Monday 2 February 2015 FTfm | 11

Exchange Traded Funds

DAVID RICKETTS

ETF providers show no sign ofcalling a halt to the drawn-outbattle over fees, with manycontinuing to cut prices acrosspopular products in Europe towin over cost-consciousinvestors and to claw at themarketshareof largerrivals.

Persuading providers toadmit that the spate of fee cutsis driven by a desire to under-cut their competitors is diffi-cult, and there is a noticeablereluctance among the largestof them to associate fee cutswithapricewar.

Nevertheless, several ofEurope’s biggest companies,including iShares, DeutscheAsset & Wealth Management,State Street and Vanguard,continued to lower fees onsomepopularETFs lastyear.

Deutsche Asset & WealthManagement, the provider of

db X-trackers ETFs, fired thestarting pistol in last year’sbattle, when in February itlowered fees on its FTSE 100,Dax, Euro Stoxx 50 and MSCIUSAfundsto9basispoints.

Several months later, Black-Rock’s iShares arm announcedfee cuts on six of its ETFs, withtotal expense ratios onproducts reduced by between5and28basispoints.

Among the products werethose offering exposure to theFTSE 100, S&P 500 and EuroStoxx50indices.

Hot on the heels of its rival,Vanguard unveiled fee reduc-tions on four of its ETFs tobetween7and25basispoints.

State Street Global Advisorsalso unveiled fee cuts on two ofits ETFs in December, follow-ing reductions earlier in theyear averaging 20 per cent

across 15 of its core equity andfixedincomeSPDRproducts.

Tim Huver, ETF productmanager at Vanguard, isamong the cohort of industryexecutives reluctant to suggestfee cuts are being driven byindustrycompetition.

“For us, low cost is the resultof our ownership structure.While many see it as a pricewar, it is really business asusual,”saysMrHuver.

Simon Klein, head ofexchange traded productdistribution and institutionalmandates Emea and Asia atDeutsche Asset & Wealth Man-agement, is also unwilling tosuggest ETF providers arewagingawarover fees.

He says a move by dbX-trackers to lower chargesacross its core range of prod-ucts last year was an attempttobroadenitsreach.

“The idea was to generatenew clients and to talk to thosethat have historically beeninvesting in institutional man-dates or index funds,” he says.“We’ve not entered into a pricewar, but this is our pricingstrategy to make these prod-ucts more in line with someother institutionalproducts.”

While ETF providers maynot be willing to admit compe-tition is driving fee cuts, thosewatching closely believe apricewar isverymuchalive.

“It’s difficult to deny thatthere is a price war betweenETF providers in Europe,” saysAdam Laird, head of passiveinvestments at HargreavesLansdown. “We’ve seen mostmajor providers cutting priceson their core products and thecost for investors has fallensubstantially.”

Jose Garcia-Zarate, seniorpassive fund analyst atMorningstar, puts it simply: “Itisapricewarandprovidersarefeelingtheheat.

“If one provider feels com-pelled to cut fees on core expo-sures, it’s because it is experi-encing pressure from a com-petitor.”

While Vanguard may viewprice cuts as business as usual,manyETFproviders inEuropehave been forced to lower feesfollowing the arrival of thelow-costUSgiant.

“What has driven price cuts[in Europe] is the entrance ofVanguard,” says Mr Garcia-Zarate.

“Its arrival has been one ofthe key catalysts. It is offeringbread-and-butter ETF propo-sitionsat lowcost.”

This battle among ETF pro-viders is likely to continue, but

some question how muchlowerfeescanfall.

Howie Li, co-head of Canvasat ETF Securities, acknowl-edges there may be a limit tothe fee cuts — even from thelargestproviders.

“We are already seeing 5basis point products and noone, even though they have

scale, can run an efficientbusiness based on little or nomargins,”saysMrLi.

Investors, adds Mr Li, maywant low-cost access to ETFs,but not at the expense of pro-viders going out of businessbecausefeesaretoo low.

Mr Li says: “Some ETF pro-viders can afford to make fee

cuts on their core productsprovided that they are able toattract investor flows throughcross-selling other higher mar-ginproducts intheirstable.”

Although ETF providershave so far dominated theprice war in Europe, Mr Lihints that growing investorscrutiny around charges could

lead to other entrants beingdraggedontothebattlefield.

“Active managers in particu-lar are facing fee pressuresfromclients,”saysMrLi.

“If there is one commontheme among investors, it islikely going to be that they arelooking for cost-efficient solu-tions for theirportfolios.”

FEES

Questions raised overhow much furthercompanies can go

‘We’ve seenmostmajor providerscutting prices oncore products’ADAMLAIRD

ETFpricewar continues to rage inEurope

12 | FTfm FINANCIAL TIMES Monday 2 February 2015

JUDITH EVANS

Investors would have been better offtracking the Russell 3000 index thanholding some of the world’s biggest“smart beta” exchange traded fundsover the past three and five years,accordingtodata fromMorningstar.

Seven of the 10 biggest smart betaETFs tracking US markets underper-formed the Russell 3000 over threeyears, and five of them over fiveyears, although the remainder gener-ated stronger returns than the indexduring this period, which was a phaseof rapid growth for smart beta, alsoknownas“strategicbeta”,vehicles.

These funds, which track indicesother than those based purely onmarketcapitalisation,effectivelyrep-resent a hybrid between active andpassive investing. Assets in smartbeta funds have risen fivefold to$544bn since the financial crisis,Morningstar says, as investors havebeen lured by fees that tend to becheaperthanfor fullyactive funds.

BlackRock’s $27bn iShares Russell

1000 Growth ETF, a smart beta fund,underperformed the Russell 3000index by 0.48 per cent over threeyears and by 0.04 per cent over fiveyears, according to data from Morn-ingstar, which chose the Russell 3000as a comparison point since it iswidely regarded as a proxy for thebroader US market. Similarly, whileanother member of its smart beta sta-ble, the $25bn iShares Russell 1000Value ETF, outperformed the Russell3000 over three years, it underper-formedover five.

Michael Rawson, analyst at Morn-ingstar in Chicago, says: “There are alot of funds here that have underper-formed, but the main takeaway hereis that your mileage may vary — thereis no guarantee that you are going toconsistentlybeat themarket.There isnofree lunchwithstrategicbeta.”

Among smart beta funds that out-performed over three and five yearswas the $17bn Vanguard Growth ETF,— ahead by an annualised 0.24 percent over three years and 0.36 percent over five years. The $15bniShares Select Dividend ETF outper-formed by an annualised 0.9 per centover five years, although it underper-formed over three, while the $10bn Guggenheim S&P 500 Equal WeightETF outperformed by an annualised

1.28 per cent over the five years.A debate has raged over defini-

tions. Morningstar adopts a broadview of the sector. It also rejects theterm “smart beta” because “there willbe periods of time where these thingsare not smart and it is not smart to beinvested inthem”,MrRawsonsays.

Mark Carver, investment strategistat BlackRock, notes that Morningstarincludes both style-based funds —which retain an element of market

capitalisationweighting—andfactor-based funds, which target, for exam-ple,momentumorlowvolatility.

Mr Rawson says each strategic betafund would only really prove its met-tle over a full market cycle. “Withpassives, you’re relying on the marketto do your homework for you, butwith a strategic beta fund, you have todo your analysis as you do with anactive fund,”hesays.

Joel Dickson, global head of invest-ment research and development atVanguard, one of the world’s largesttracker fund providers, says theresults might reflect the particularmarketconditionsduringtheperiod.

Fees on the largest 10 US-investedstrategic beta funds range from anannual 0.09 per cent to 0.39 per cent.

Straight trackers, of course, alsocome with a fee: the passive Russell3000 ETFs start at 0.15 per cent andS&P 500 ETFs at 0.05 per cent. Trad-ing costs for strategic beta funds mayalsobehigher, saysMrDickson.

Mr Rawson adds that while provid-ers are grasping for market shareamong passive ETFs, there are gaps inthestrategicbetamarket.

However,MrDicksonissceptical.“What we’ve seen in the US ETF

market to date is that broad-based[passive] exposures are the ones thathave an overwhelming amount of thetotalassets,”saidMrDickson.

“Investors have . . . [shown] whatthey really like for long-term strate-gic investments are core, low-costtotalmarketapproaches.”

What’s in a name? Some advisers reject the use of the term ‘smart beta’

HYBRID TRACKERS

Seven of the 10 biggestvehicles underperformRussell 3000 index

Smartbeta isnoguaranteeyouwill beatthemarket

‘There is no guaranteeyouwill beat themarket.There is no free lunchwith strategic beta’

Exchange Traded Funds

FINANCIAL TIMES Monday 2 February 2015 FTfm | 13

ETFs 18 years to reach $1tn in2010and22years tohit$2tn in2014. In the US, ETFs alreadyaccount for 11.3 per cent of USmutual fundassets.

It is not surprising ETFshave been growing faster thanmany investment products, astheyareauniquelydemocraticand useful proposition used byinstitutions, financial advisersand retail investors. They offertransparent, liquid and cost-efficient access to many assetclasses and markets aroundthe world and allow a smallminimum investment size —typically, one share would costless than$200.

I expect the assets investedin ETFs globally will continueto grow and will surpass theassets invested in hedge fundsto reach the $3tn milestone infirsthalfof2015.

However, the ETF industryfaces hurdles that must beovercome if this expectedgrowthis tobeachieved.

McKinsey, the consultancy,expects assets invested inactive ETFs to explode from$25bn today to $500bn by2020. But this will depend onthe launch of non-transparentactive ETFs. Many traditionalactive asset managers havemade filings with the US Secu-rities and Exchange Commis-sion over the past six yearsrequesting approval to listnon-transparentactiveETFs.

However, inOctobertheSECdenied such requests fromPrecidian and BlackRock. It isnot certain whether the SECwill everapprovetheproducts.

Similarly, smart beta, whichconstitutes one of the fastestgrowing segments of the ETFindustry,hascomeunderscru-tiny from the US FinancialIndustry Regulatory Author-ity, which said in January itplans to examine ETFs track-ingsmartbeta,ornon-market-cap or alternatively weightedindices. It is concerned thatwhile back-tested results andsome academic research havehighlighted the potential

efficacy and attractiveness ofalternatively weighted indices,it is an open question how theindices and products trackingthem will behave in differentmarketenvironments.

Popular US retirementaccounts, known as 401 (k)

M any will be sur-prised to learnthat exchangetraded fundswill turn 25 on

March9.This year marks the silver

anniversaryof the listingof theTIP 35 ETF (Toronto IndexParticipation Fund) in Canadaon the Toronto Stock Ex-change.

Manypeople incorrectlycitethe SPDR S&P 500 ETF (SPY),listed in the US on January 221993,as thefirstETF.

TheETFindustry(whichforthe purposes of this articleincludes exchange tradedproducts) has a lot to cele-brate, as a number of mile-stones were reached at the endof 2014: the global ETF indus-try gathered a record level of$61.4bn in net new assets inDecember and a record level of$338.3bn for the full year;assets globally reached a newrecord $2.79tn invested in5,581ETFs,with10,771 listings,from239providers listedon62exchanges in50countries.

To put these numbers intoperspective, it took the globalhedge fund industry 56 yearsto reach $1tn in 2005 and 62years to reach $2tn in 2011,accordingtodata fromHFR.

ETFs have taken 19 years toreach $1tn and 23 years toreach $2tn. At the end of 2014,the assets invested in 8,377global hedge funds are just$59.9bn larger than the globalETFindustry.

In theUS, theassets investedin ETFs broke through the$2tn milestone at the end of2014. It took the US mutualfund industry 67 years togather $1tn in assets in 1990and 70 years to reach $2tn in1993, ICI data show. It took US

Happy anniversary—but challenges lie aheadCOMMENT

DeborahFuhr

plans, have also been underthespotlight.

Many providers have triedto create solutions that wouldallow ETFs to work withinsuch plans, which account forapproximately $4.3tn inassets. Large 401 (k) plans

usually contain only mutualfunds as they allow for alloca-tions of fractional shares —currently not possible withETFs.

We need to educate institu-tional investors, financialadvisers and retail investors

on when and why ETFs may bebetter than other products,but how to best compare,select and trade ETFs are stillbigchallenges for the industry.

Deborah Fuhr is managingpartneratETFGI

Milestone: ETFs first appeared in Canada — Pawel Dwulit/Bloomberg

Exchange Traded Funds

SIMONEY KYRIAKOU

Syriza’s electoral victory inGreece and fears that itsanti-austerity stance couldspread to other eurozonecountries have sent many

investors scuttling back to the per-ceivedsafetyofgoldandgoldfunds.

Commodity funds in general hadalready begun to enjoy strong inflowsspurred by uncertainty over the deci-sion in January by the European Cen-tral Bank to begin quantitative easingand the Swiss central bank’s decisiontoremoveitscurrencyceiling.

Cameron Brandt, director ofresearch for fund data companyEPFR Global, says: “Gold fundsrecorded their biggest weekly inflow[in the week ending January 23] sincethe fourth quarter 2011. The desire toinvest in tangible assets — even thoseunder pressure from supply anddemand factors — saw commoditiesand energy sectors take in more than$3.5bnbetweenthem.”

Data from ETF Securities show thatits physically backed gold ETPsattracted $120m in net inflows in thefirst threeweeksof January.

The uptick in interest follows mas-sive outflows in the fourth quarter of2014. ETF Securities’ Gold ETPs saw$3.1bn in net withdrawals globally,predominantly from US investorswhose confidence in US markets wasstrengthening.

But it was not just the yellow metalthat proved popular. Despite the pre-cipitous fall in the price of oil, ETFSecurities’ Brent Oil ETPs saw $204min net European inflows from January1-21 while WTI ETPs garnered $297mworth of investors’ money for thesameperiod.

These inflows could be ascribed inpart to the growing popularity ofETFs in general — 2014 saw a total of$2.79tn invested in ETFs globally,according to consultancy ETFGI.

However, Rima Haddad, head ofinstitutional sales for ETF Securities,believes investors are now looking forsafety and are attracted to commodi-ty-basedETPsbecauseof theirattrac-tivediscounts.

For example, positive noises com-ing from the US Federal Reserve in2013 sparked a mass sell-off in gold.About 29m ounces, which ETFGIpriced at over $40bn, were sold byETF investors, especially in April andJune 2013. They continued to shedgoldassetsandgoldETPs in2014.

Since the start of January, however,goldpriceshavebeenappreciating.

“The unpredictability of what pol-icy makers will do next is a big factoras to why people are positioningthemselves in the gold market,” saysMs Haddad. She adds events such asthe EUR/CHF peg dropping 30 percent in one day last month as theSwiss franc rose against the Euro, bigQE programmes and elections in theeurozoneaddtothedisquiet.

“It’s no wonder people feel equityexposed. Gold can provide a much-needed protection in this unstableenvironment and because ETFs offercheaper, liquid and more price-trans-parent ways to get this hedge thaninvesting directly in bullion, we haveseen higher inflows than usual intocommodityETPs.”

Roland Khounlivong, head of deal-ing and settlements at GoldMoney,agrees: “Investors do seem to be add-ing gold into their portfolio as a havenamidfurthereconomicuncertainty.”

It certainly seems that commodityETPs are being used as a means oflong-termdiversification,ratherthanbyinvestorshopingforaquickbuck.

Philip Milton, an independent

Exchange Traded Funds

Solidinvestment:ETPs in goldand oil providea hedgeagainstuncertainty inthe Eurozonefollowing theelecton victoryof AlexisTsipras, below,in Greece lastmonthSeongJoon Cho/Kostas Tsironis/Bloomberberg

PHYSICAL ASSETS

In the hunt for havens, it isnot just the yellow metalthat is proving popular

Uncertainty sparks a rush for goldinvestment adviser, says: “Anythingcan happen in the markets and so Ihave been increasing exposure tocommodity-based assets. I am addinggold in the form of a physicallybacked ETF, but I am looking for anuncorrelatedhedge,notaswiftgain.”

Whether retail investors will con-tinue flocking into commodity ETPs

remains to be seen. Equity marketsare becoming adept at pricing in theeffects of QE, and the FTSE Eurofirst300 rose strongly on the back of theEU’sassetpurchasingprogramme.

Will the hot money flow back intoequity ETFs? Investors can be fickle,as the recent outflow and inflow datashow. Whatever happens, as MrKhounlivong says, “It’s going to be aninterestingyear”.

‘The unpredictability ofwhat policymakerswill do next is abig factor’RIMAHADDAD, ETFSECURITIES