As we approach the end of 2012, the time has come to take stock of the last 12 months. 2012 has proved a fertile year for the European exchange-traded fund (ETF) and exchange-traded product (ETP) industry, with growth in assets under management (AUM) well into double digits. Specifically, we’ve seen around 20% year-on-year growth in AUM based on data from the end of November. The ETP industry now has around €275 billion in AUM due to the virtuous combination of roughly €15 billion in net inflows and capital appreciation across broad asset classes. These figures compare very positively to 2011, which was a year that closed with a slight year-on-year decrease in AUM as net capital losses (mostly owing to poor equity markets) offset overall positive money flows.
Show Me the Money: A Round-Up of Where Assets Flowed in 2012
ETP investment flows in 2012 have remained broadly underpinned by a “risk-off” rationale, as hopes for improved economic performance in the early stages of the year gradually gave way to concerns of a renewed slowdown. Growth expectations were duly revised down on the sober realisation that emerging market economies could not transition overnight from export-oriented to consumer-driven entities.
As such, the bulk of new net money into ETPs has mostly favoured the perceived capital-protective properties of corporate and emerging market government bonds and gold. Yet none of these top the list of best performing ETPs of the year. You’d have been better off investing in Turkish, European Insurance or European Auto & Parts equity ETFs. Similarly, you’d have been better off placing your money in silver, corn and soya bean ETPs instead of jumping onto the gold train.
Despite the majority of money flows directed at fixed income and commodity ETPs, equity exposure remains the cornerstone of the European ETP industry. Equity has an overall market share of 58.5% of total AUM for all ETPs. It’s worth noting that the assets under management in equity ETFs in 2012 rose to €160 billion from €134 billion in 2011. This was primarily driven by capital appreciation.
Meanwhile, the market share of fixed income ETFs has grown from around 15.5% to 17.5%, while the market share for commodity ETPs has remained broadly unchanged at 20%. On the losing side, both in terms of flows and AUM, we find money market ETFs. This is an asset class with next to no financial appeal in the current ultra-low interest rate environment.
Regulatory Changes for the ETP Industry
The year 2012 could be classed as the year of regulatory clarity. After a lengthy consultation, the European Securities and Markets Authority (ESMA) published the final guidelines on ETFs in late July. Morningstar gave a broad welcome to these guidelines, seeing them as setting the basis for enhanced transparency to the benefit of ETF investors.
The ESMA guidelines also helped settle the physical-synthetic replication debate, declaring both as valid methodologies. After a bitter fight over the pros and cons of physical versus synthetic ETFs in 2011, the European ETF industry essentially signed a “peace treaty” well ahead of the publication of the ESMA guidelines, perhaps sensing that the debate had been damaging to the reputation of ETFs as a whole.
Regardless of these developments, investors clearly revealed their preference for physical replication ETPs based on where they were putting their money in 2012. According to Morningstar data, synthetic ETFs in Europe once had an average of 45% of the ETF market before 2011, but that market share has declined to 35% by the end of this year. Meanwhile, the two leading swap-based European ETF providers, db X-trackers and Lyxor, have responded to this general trend by launching a series of physically-replicated ETFs to either run alongside or partly substitute their existing synthetic line-up.
Consolidation and Closures in the ETP Industry
This year witnessed a huge number of ETP closures. Roughly 60 ETPs were shut down in 2012, compared to an average of 20-25 in the past four years. Some providers may also be looking to throw in the towel. For example, Credit Suisse has put its ETF business up for sale. These factors could indicate that consolidation in the ETP industry is well underway.
Of course, it must be noted that, from a statistical standpoint, an increase in ETP closures after four years of heavy ETF proliferation should not be seen as unusual. The common view amongst ETP experts is that it takes two to three years for a new ETP to prove its worth, and so the closures in 2012 indicate that ETP providers may have become more willing to ditch unprofitable funds rather than allow them to piggy-back on successful ones. Getting rid of unsuccessful funds ultimately frees up financial resources that could translate into lower management fees for the most popular products.
Digging deeper into the ETP closures data we see that half of the funds liquidated in 2012 provided exposure to equity markets, while just over 25% fell into the category of “alternative” where Morningstar includes inverse and leveraged instruments more adept to short-term trading than long-term investment purposes. By contrast, closed ETPs providing exposure to fixed income markets were only 15% of the total. This gives us a strong hint as to how the ETP market has developed in Europe, with fixed income exposure as a late starter. Equally, it gives us some clues as to where the key areas for product development would be in the years ahead.
Expectations for the ETP Industry in 2013
Diminishing room for new plain vanilla equity ETFs means that product development in this asset class could be increasingly defined by more specialised offerings. We thus expect more launches of so-called “smart beta” ETFs, which are ETFs tracking alternative-weighted or strategy indices. Although equity exposure will be the most likely testing ground for these “quasi-passive” products, fixed income won’t be immune to the trend. However, as previously hinted, plain vanilla fixed income ETFs still have plenty of room to grow both in terms of new products and new clients.
The goal for ETP providers is to offer all kinds of products in all kinds of asset classes, which will cater to investors’ strategic and tactical needs within their portfolios. We’ll probably hear more about ETF-based managed investment portfolios and ETF-based fund of funds in the coming year. But at the same time, this trend for specialisation will go hand-in-hand with extra efforts on the basic education front. After all, despite the steady flow of new money into European ETPs over the last five years, the fact is they still only represent a small fraction (5%) of the wider investment fund universe in terms of AUM. There is plenty of room for growth and much more needs to be done to increase the visibility of ETPs. The pace of progress on this front in Europe is uneven and largely determined by legislative changes in individual countries. While in some nations, ETPs should be expected to remain the preserve of institutional investors, in others such as the UK, the expectation is that ETPs will grow in populartiy amongst individual investors, especially once the Retail Distribution Review (RDR) is enforced in 2013.
Central Bank action will also remain a key shaper of trends in the investment industry. Ultra-easy monetary policies might make investors more willing to place their money in riskier assets. However, against the backdrop of “ultra-easy” policy settings across the globe we could see two very distinct approaches to policy formulation, one headed by the US Fed (and the BoE) and the other by the ECB, depending on the relevance of inflation as a policy target. This could ultimately have important implications for foreign exchange valuations; something investors will need to carefully monitor.
