The recent survey by EDHEC-Risk Institute (EDHEC) of European professional investors into their practices, perceptions and future plans for investing into Exchange Trade Funds (ETF) is of interest and well worth reading.
The survey gathered information from 163 European investment professionals. Respondents to the survey were high-ranking professionals within their respective organisations, representing firms with large assets under management (36% of respondents represent firms with assets under management exceeding €10bn). Respondents to the survey are from the United Kingdom, European Union, Switzerland, and a small sample from other countries outside the European Union.
What is the dominant purpose of ETF usage?
The survey results clearly indicate that the current usage of ETFs is dominated by a truly passive investment approach. “Despite the possibilities that ETFs offer – due to their liquidity – for implementing tactical changes, they are mainly used for long-term exposure.”
Gaining broad market exposure remains the main focus of ETF users – 71% of respondents use ETFs to gain broad market exposure, versus 45% who use ETFs to obtain specific sub-segment exposure (sector, style).
“In line with this expression of conservatism in their use of ETFs, which is mainly focused on traditional passive management, it can also be noted that investors are largely satisfied by ETFs in traditional asset classes but more reserved about ETFs for alternative asset classes”
What are the future growth drivers?
The European ETF market has seen tremendous growth over the past decade or so. At the end of December 2017, the assets under management (AUM) within the 1,610 ETFs constituting the European industry stood at $762bn, compared with 273 ETFs amounting to $94bn at the end of December 2006 (ETFGI, 2017).
“A remarkable finding from our survey is that a high percentage of investors (50%) still plan to increase their use of ETFs in the future, despite the already high maturity of this market and high current adoption rates.”
Why? lowering investment cost is the primary driver behind investors’ future adoption of ETFs for 86% of respondents in 2018 (which is an increase from 70% in 2014).
Interestingly, EDHEC find investors are not only planning to increase their ETF allocation to replace active managers (70% of respondents in 2018), but are also seeking to replace other passive investing products through ETFs (45% of respondents in 2018).
How do investors select ETFs?
Cost and quality of replication. Both of which are more easy to identify from a quantitative perspective.
EDHEC argue” Given that the key decision criteria are more product-specific and are actually “hard” measurable criteria, while “soft” criteria that may be more provider-specific have less importance, competition for offering the best products can be expected to remain strong in the ETF market. This implies that it will be difficult to build barriers of entry for existing providers unless they are related to hurdles associated with an ability to offer products with low cost and high replication quality.”
A section I found more interesting:
What are the Key Objectives Driving the Use of Smart Beta and Factor Investing Strategies?
EDHEC find that “the quest for outperformance is the main driver of interest in smart beta and factor investing. In fact, 73% of respondents agree that smart beta and factor investing indices offers significant potential for outperformance”
The most important motivation behind adopting such strategies is to improve performance.
Interestingly they find that the actual implementation of such strategies is still at an early stage
EDHEC found that among those respondents who have made investments in smart beta and factor investing strategies, these investments typically made up only a small fraction of portfolio holdings.
“More than four-fifths of respondents (83%) invest less than 20% of their total investments in smart beta and factor investing strategies and only 11% of respondents invest more than 40% of their total investments in smart beta and factor investing strategies”
As they say, ”It is perhaps surprising that almost a decade after the influential report on Norway’s Sovereign Wealth Fund (see Ang, Goetzmann and Schaefer, 2009), which emphasised the benefits of factor investing for investors, adoption of such an approach remains partial at best.
Not surprisingly, those that use factor strategies, the use of them is not related to factor timing and more to extracting the long term premia from the factors.
In relation to fixed interest, “17% of the whole sample of respondents already use smart beta and factor investing for fixed-income. Some 80% of this sub-sample of respondents invest less than 20% of their total investment in smart beta and factor investing for fixed-income.”
It appears that respondents show a significant interest for smart beta and factor investing for fixed-income. The interest appears to be there, but likelihood of implementation not so much.
Interestingly, from responses “it thus appears that investors are doubtful that research on factor investing in fixed-income is sufficiently mature at this stage. Given the strong interest in such strategies indicated by investors, furthering research in fixed-income factor investing is a promising venture for the industry.”
The survey looked into a number of other areas, for example do investors have the necessary information to evaluate smart beta and factor investing strategies? What requirements do investors have about smart beta and factor investing strategy factors?
What are investor expectations for further development of ETF products?
The following areas where identified as potential are of further ETF product development:
- Ethical/Socially Responsible Investing (SRI) ETFs,
- emerging market equity ETFs and emerging market bond ETFs,
- ETF indices based on smart beta and on multi-factor indices, EDHEC note that more than two-fifths of the respondents want further developments in at least one of the categories related to smart beta equity or factor indices. “This shows that the development of ETFs based on advanced forms of equity indices is now by far the highest priority for respondents.”……… “We also note that additional demand for ETFs based on smart bond indices is not so far behind”…..
Fixed Income and Alternatives
The survey results indicate that respondents desire further development in the area of fixed income and alternative asset classes.
Also there is an increased interest in integration of ESG in smart beta and factor investing, and strategies in alternative asset classes.
“So, there is still a lack of products when it comes to asset classes other than equity, and this lack is particularly critical for the fixed-income asset class, which is largely used by investors.”… “It is likely that the development of new products corresponding to these demands may lead to an even wider adoption of smart beta and factor investing solutions.”
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3 thoughts on “Future trends in ETFs are rather daunting. Are you prepared?”
Useful summary of the survey, thanks Michael. Do you foresee the end of active managers at some point given the stated appetite for more and more ETF investments?
Thanks Nicholas. Yes still see a role for active management, where returns are predominately driven by individual company exposures. Nevertheless, ETF’s will continue to be disruptive to both active and passive providers, not only in the traditional assets classes, particularly fixed income, but also from increasing investments into the likes of alternatives, smart beta, and factor based strategies.
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