The benefits of using ETFs are well known and understood by sophisticated investors and advisors in the UK, such as private banks, wealth managers and asset managers.
ETFs are commonly used instruments in portfolio construction. They are also frequently used to gain fast exposure to markets. They are seen as simple, transparent and accessible instruments by this community. Many of the most sophisticated investors and advisors interviewed emphasised that what they want from ETFs are simplicity, transparency, liquidity, low tracking error and even lower costs.
Commodity and fixed income ETFs are now used almost as frequently as equity ETFs. This is a significant change from previous studies that IFI Global has done with ETF users. In the past, equity ETFs were more dominant. (But this may be as much of a reflection on where we are in the market cycle as it is upon the establishment of ETFs in non-equity asset classes.)
Investors use equity ETFs across market areas: sector, global, country, regional, value, emerging market, etc. The results of this research show that ETFs are well established, and wanted, in each and every area of the equity market.
Over 50% of the advisors interviewed said that their remuneration model is now fee based. A further 46% said that they operate under a combined fee and commission based system of remuneration. Only one advisor reported working under a commission based system exclusively.
Whilst the largest proportion of respondents (53%) use ETFs to gain short-term exposure to markets, 28% opt for long-term exposure, while 24% rely on a combination of both.
Liquidity and transparency were given equally as the two most important reasons for using ETFs.
Frequent users of ETFs, in particular, want transparency in their cost structure, investment process and risk management policies. As one interviewee put it, “You cannot have too much transparency.” Allied to this, a number of respondents were concerned that not enough due diligence is being done on underlying ETF structures and their underlying assets.
Synthetic ETFs are viewed with some suspicion by a number of the less frequent users as well as by those that don’t use ETFs at all. Frequent users of ETFs are comfortable using these instruments.
The market crisis has altered many investors’ views on asset allocation in ways which should benefit ETFs. What many want today is more liquidity (than they required before the crisis), more diversification and more flexibility. Tactical asset allocation is becoming ever more popular today. There is also more emphasis and focus on potential counter-party risk.
It is clear that additional education on ETFs is needed in the UK, in particular for pension funds and IFA networks. Some companies in these categories are using ETFs, but many more simply do not know enough about them to use them. One pension manager remarked that he had once had a presentation on ETFs but decided that they were “too intangible”.
Non users interviewed also often expressed regulatory concerns. One pension fund said that it had used ETFs until recently, but stopped following concerns raised by UK regulators. And, one of the UK’s largest pension fund consultants said that the regulatory system in the UK has made it much harder for pension funds to use ETFs than it should.
Other reasons for avoiding ETFs included a strong preference for active management and the herd instinct in the pension fund community. A number of pension fund managers said that they would like to see other pension funds using them before they will consider doing the same. One large UK pension fund said that they do not use ETFs because they are categorised internally as being derivatives (even though he knows that they are not).
1 Has your overall knowledge or perception of ETFs changed in anyway over the past 12 months? If so please could you describe how it has changed?
*4 respondents said that they are more likely to use ETFs today than they were 12 months ago. 10 said that they are less likely.
Second Survey (Fieldwork December - February) Selective quotes representing respondents views: “ We are concerned that the next big disaster (in investing) will be in ETFs ……….until we are fully convinced of all downside risks we wont be using them.” “ Yes - due to FSA comments, the media, our clients have shown anxiety towards synthetics and therefore they're no longer using them. Basically, despite the advantages/cost-savings of synthetics, it doesn't make economic sense to sell them to retail clients at the moment because of the extra labour required (explaining the structure, risks etc.)” “ Most ETFs are liquid and transparent. We will continue to use them.” “ There has been much media scrutiny of ETFs which is good for the industry …. It is right that synthetics should come under the spotlight. We will continue use all forms of ETFs.” “ We are much more knowledgeable about ETFs than we were a year ago.”
2 Has the recent market turbulence made it more or less likely that you will use ETFs?
Second Survey (Fieldwork December - February) Selective quotes representing respondents views: “ We will use ETFs more because we are looking for innovative ways to access the market.” “ ETFs are ideal instruments to use in current market conditions ….. we will likely be using them even more in 2012 than we already do.” “ Our equity market exposure is increasingly driven by top down allocation decisions, particularly in the emerging markets. You have to be in the right markets. ETFs are good instruments to use for this purpose – although there is still limited in coverage in some emerging market areas.”
3 If you use ETFs both tactically and strategically has that balance altered as a result of the market turbulence?
Selective quotes representing respondents views: " The diversification at the ETF level and our managed fund level means we have precise control over volatility and correlation measures in rising, falling and volatile markets.”
5 What would encourage you to use ETFs more in the future?
Following are the main areas, based upon the interviews to date: a) More transparency from issuers. In particular those that use the swap based ETF model need to do more to explain how this works and what, if any, downside risks there are to using this particular type of exchange traded fund. This is a commonly held view b) Lower fees c) More coverage – particularly of emerging markets d) Liquidity issues need to be addressed by issuers. What is the downside of being in an ETF in one of the more esoteric market areas (particularly non equity) such as commodities etc is in terms of liquidity. How new baskets of ETFs are created, and who does this, needs to be properly explained – in particular in less liquid market areas
6 What would discourage you from using ETFs more in the future?
Main areas of response: a) A return to a more bottom up equity exposure b) If active (long only) management – net of fees - is seen to be more effective than passive funds like ETFs. But this is unlikely say most interviewees c) A disaster in the industry d) Failure to address the points made in response to question 5 (in particular transparency)
7 Do you believe the perceived risks associated with both asset-backed and swap-backed ETFs have been accurately portrayed in the media? (There has been a lot of coverage within the media regarding the differences between physically-replicating and synthetically-replicating ETFs and comments have been taken from the ETF providers as well as canvassed independent opinion. Do you think the differences between the replication structures have been correctly explained in an unbiased manner with an adequate level of depth to fully answer investor questions on this matter?)
The issue of asset backed vs swap backed ETFs has caused quite a lot of confusion in the market. Respondents come into one of three broad categories:
Second Survey (Fieldwork December - February) 7 a) Sophisticated and frequent ETF users who do not need to have the differences explained and remain happy to use swap back ETFs. b) Less frequent, often relatively new users (particularly institutional investors and IFAs) as well as those looking to invest via ETFs for the first time. This group are often confused by the physical vs swap back debate. The media coverage and/or general conversations they have had with colleagues might have had some sort of negative impact in some cases. c) Those that do not use ETFs and then cite the negative media coverage as an excuse for not doing the work to find out more about exchange traded funds. Selective quotes representing respondents views: “ Synthetics are easier to track an index, they are cheaper too. More providers are going down the synthetic route.” “ There is confusion over the different forms of ETFs and their associated risks". “ These things are rarely portrayed accurately in the media.”
8 Do you think that ETF issuers could be more innovative? Are there any market areas that you would like to see covered by ETFs that currently are not (for example, more currency hedged products)?
Innovation is not a particular concern. Respondents are more interested in receiving assurances as outlined than seeing ETFs move into new areas. Some respondents said that there has been too much innovation in the ETF industry over the last few years and that issuers should concentrate on doing the basics well. Those that want more innovation would like to see more country-specific targeted ETFs (to take advantage of market swings), more fixed income replication.
There has been relatively little change in views of ETFs in the UK over the last year despite the extensive and often negative coverage given to them in the British media. Insofar as it has had an impact it has been with those less familiar and knowledgeable of ETFs.
Market turbulence is good news for ETFs. The ability to get in and out of markets quickly by using these instruments is understood by all users, as is their ease of use.
Recent market conditions have made it more likely that users will use ETFs for short term tactical reasons (whilst still using them for longer term strategic reasons).
ETF education is badly needed for the institutional and IFA market in the UK. Wealth managers, private banks and independent asset managers, on the other hand, are very familiar with these instruments.