It can be difficult to keep up with the sheer pace of change in the exchange-traded products industry. A scant decade after the first ETF listed in Europe, there are now nearly 1,400 exchange-traded products (ETPs, an umbrella term including exchange-traded notes and ETCs as well as ETFs) with over two times as many listings. Assets in all of these products totalled nearly £160 billion at the end of September 2010. From the first two funds covering the bog-standard STOXX 50 and EURO STOXX 50 indices, we now have ETPs that provide access to nearly every regional equity index, as well as less useful investments like lean hog futures and water-related global utilities.
So what will 2011 bring? The most obvious prediction is more assets. Inflows to exchange-traded funds stayed strong even during the market crash of 2008 and 2009, as investors continued to embrace the improved liquidity and lower costs of this new fund structure. Given the current rate of inflows, and mild global equity returns of five to ten per cent, assets in the European ETP market could easily exceed £200 billion by the end of 2011. We only see this trend potentially accelerating as we hit 2012 and beyond, as regulatory changes begin to make exchange-traded funds a more appealing choice for the vast number of retail investors currently locked into traditional funds.
The retail market for ETPs has already started to expand in the UK and Germany, which leads to the second prediction: trading volume on the exchanges will grow even more quickly than assets in 2011. The large institutional investor base for European ETPs trades infrequently, and typically place huge block orders through the biggest market makers. However, as retail investors and smaller, more nimble hedge funds start to join the market, they would rather trade via the exchanges to allow a degree of anonymity and smaller order sizes. As these smaller ETPs’ shareholders increase the liquidity available on exchanges, more of the current institutional investors will also turn toward exchange trading rather than going through market makers to save on execution costs. Ultimately, this could lead exchange volumes to grow ten to twenty percentage points faster than assets under management.
A number of new entrants came to the European market in 2009 and 2010, but we do not expect 2011 to be their year. The big three of iShares, Lyxor, and db x-trackers already hold around two-thirds of the total ETP assets in Europe, and their share is likely to stay strong in the coming years. New entrants have mostly replicated existing products, but the current market leaders already participate in nearly every European market. There are also few asset class niches left to fill, with ETF Securities already occupying the commodities, leveraged and inverse, and currency spaces. So the big players look set to press their advantage, able to charge lower fees on their bigger asset bases and offer lower trading costs due to their higher volumes.
Credit Suisse looks like the only credible challenger due to their recent heavy investments in new marketing staff, a recognisable brand name, and an expanded product line-up. However, with a mere 5% of the European market and little presence outside their home base of Switzerland, there is a long way to go to catch the big three. Finally, the other provider we expect to continue growing swiftly is Source, which has carved out a respectable niche by focusing on replacing equity derivatives with ETFs in hedge fund portfolios. This narrow purview keeps Source to a fairly limited product line-up, so it does not threaten the major ETP incumbents. But they have been very successful thus far, and still have plenty of room to grow in their chosen sub-market.
Our final prediction is that new ETF launches in 2011 will concentrate on the emerging markets and credit bonds. Fixed income remains one of the few asset classes that ETFs do not yet slice and dice into the tiniest sub-sectors, but this will not remain the case for long. iShares already launched the first high-yield bond ETF just a few months ago, and we expect more credit-focused ETFs in 2011 covering the euro, sterling, and dollar bond markets. We expect more emerging market funds to come out as providers chase the hottest investment story around. Inflows to emerging market equities and bonds have been huge in 2010, so expect launches of local-currency emerging market bond funds, more single-country equity funds, and perhaps even sector-specific or single-country small-cap ETFs. Some of these new funds may prove useful, but just like with all other investment products, most will simply be chasing assets. That is one thing we can be sure will never change.
