etfs - past, present, future

27
<#> © 2010, Morningstar, Inc. All rights reserved. ETFs: Past, Present, and Future Bradley Kay Associate Director, European ETF Research Ben Johnson ETF Strategist, European ETF Research March 25 th , 2010

Upload: morningstar-uk

Post on 25-May-2015

373 views

Category:

Documents


2 download

TRANSCRIPT

Page 1: ETFs - Past,  Present,  Future

<#>

© 2010, Morningstar, Inc. All rights reserved.

ETFs: Past, Present, and Future

Bradley KayAssociate Director, European ETF Research

Ben JohnsonETF Strategist, European ETF Research

March 25th, 2010

Page 2: ETFs - Past,  Present,  Future

2

Overview

× A Very Brief History

× The ETF Marketplace Today

× What Is An ETF?

× What Advantages Do ETFs Offer?

× Trends For The Future

Page 3: ETFs - Past,  Present,  Future

3

Whence We Came: ETF Market Evolution

Page 4: ETFs - Past,  Present,  Future

4

A Very Brief History× 1990 – The SEC issued the Investment Company Act Release No. 17809.

This would ultimately facilitate the creation of mutual funds that were able to create and redeem shares intraday.

× 1993 – SPDRs S&P 500 begins trading on the AMEX in January.

× 1999 – The Tracker Fund of Hong Kong (TraHK) was launched in November, becoming the first ETF in Asia.

× 2000 – In April, the European Exchange Traded Fund Company launched a pair of listed diversified return securities (LDRS) on the Deutsche Borse. The funds, which tracked the EURO STOXX 50 and STOXX 50 indices were co-managed by Merrill Lynch. Later in the same month, iShares launched the first ETF in the UK, the iFTSE 100.

× 2003 – In February the first ETF on a fixed-income index in Europe was launched. The ETF eb.rexx Government Germany was issued by Indexchange and tracked the Eurex Bonds Government Germany index (eb.rexx).

× 2003 – ETF Securities launches the world’s first exchange-traded commodity Gold Bullion Securities in Australia and London.

Page 5: ETFs - Past,  Present,  Future

5

European ETF Asset Growth by Broad Asset Category

Source: Blackrock, Bloomberg

£0

£25

£50

£75

£100

£125

£150

£175

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 J an-10

ETF As

sets

(GBP

Billion

)

Equity Assets Fixed Income Assets Commodity Assets

Page 6: ETFs - Past,  Present,  Future

6

Where We Are Now

Page 7: ETFs - Past,  Present,  Future

7

Category/Asset Class # of ETFs Total Net Assets As a % of Total Industry Assets

Europe Equity 424 60,526,666,986 42.47

International Equity 243 32,723,777,179 22.96

Fixed Income 153 30,582,153,845 21.46

Traditional Asset Classes 820

£123,832,598,010 84.68

Commodity 291 16,982,675,211 11.92

Other 18 1,476,473,085 1.04

Currency 22 208,379,461 0.15

European ETF Industry Total 1151

£142,500,125,766 100.00

Morningstar Data as of Feb. 2010

Proliferation of Asset Classes

Page 8: ETFs - Past,  Present,  Future

8

Proliferation of Asset Classes

× In the beginning, ETFs only offered broad index and equity sector exposure

×Now, ETFs offer access to nearly every asset category imaginable

×Fixed Income×Fundamental Indexes×Commodities×Currencies×Leveraged Equity×Hedge Fund Strategies×Niche Sector Slicing

Page 9: ETFs - Past,  Present,  Future

9

What Is An ETF?×An umbrella term, covering a broad array of legal

structures with a proliferation of abbreviations× ETFs× ETCs

×Defining attributes× Tracks a specific index or a strictly-defined

portfolio of securities×Almost exclusively passive investments

× Traded on a stock exchange×A retail investment vehicle by nature

× Short-term arbitrage opportunity via daily or weekly share creations/redemptions

× ETNs× ETPs

Page 10: ETFs - Past,  Present,  Future

10

What Is An ETF?

×Typically UCITS III compliant× Diversified portfolios of securities: stocks,

bonds, derivatives

×Physical-replication ETFs× Match their index by holding the actual

securities in a unique trust× Full or Sampled replication

×Synthetic-replication (or swap-based) ETFs× Obtain their index exposure through OTC

swap contracts× Hold securities in their own trust and/or have

collateral pledged to mitigate counterparty risk

Page 11: ETFs - Past,  Present,  Future

11

What Is An ETC?

×Formerly “Exchange-Traded Commodity”, now also currency funds

×Typically does not meet diversification standards for UCITS III

× Single commodity funds× Single currency funds

×Debt instruments issued by Special Purpose Vehicles (SPVs)

× Degree of counterparty risk varies widely

×European Union Prospectus Directive allows broad distribution

Page 12: ETFs - Past,  Present,  Future

12

What Is An ETC?

×Physically-backed× Only precious metals× Virtually zero counterparty risk

×Synthetic-replication× SPV sometimes keeps the ETC’s capital, but

usually given to total return swap (TRS) counterparty

× Collateral may be allocated through a third-party custodian or simply pledged by the TRS counterparty

× Acceptable securities for collateral can vary widely from provider to provider

× Read Those Prospectuses!

Page 13: ETFs - Past,  Present,  Future

13

What Is An ETN?

×Exchange-Traded Note

×Debt instrument issued by a backing bank× Senior, unsecured debt of that bank× Substantial counterparty risk!

×Not a very popular vehicle in Europe, with only two issuers

× Lyxor pledges collateral for their ETNs× Barclays Capital issues uncollateralized ETNs

×Much more popular in the U.S., where they have substantial tax advantages for futures-dependent indices such as commodities

Page 14: ETFs - Past,  Present,  Future

14

Innovation, You Say?

Page 15: ETFs - Past,  Present,  Future

15

What’s So Great About ETFs?

× Incredibly low costs

× Intra-day liquidity and real-time trading

×Access to new asset classes and strategies

ETFs bring the institutional to the individual

Page 16: ETFs - Past,  Present,  Future

16

Low Costs

×Passive investments× No expensive analysts× Typically low turnover

×Numerous back-office and mid-office efficiencies for providers

× Only need to issue and redeem shares with a limited number of market makers

× Shifts portfolio trading costs to ultra-efficient market makers or swap counterparties

×Custodial costs have economies of scale due to cross-listings and broad distribution pulling in assets from across Europe

Page 17: ETFs - Past,  Present,  Future

17

Intra-Day Liquidity and Real-Time Trading

×Real-time execution means that you know the price you are paying

×Can provide more liquid exposure to illiquid asset classes

× When corporate bond markets froze in 2008/2009, credit bond ETFs kept trading

×Market makers arbitrage away premiums and discounts, keeping prices close to fair value

×Warning: This shifts the onus of ensuring fair execution onto the final buyer rather than the provider

× Liquidity differs from fund to fund

Page 18: ETFs - Past,  Present,  Future

18

Access to New Asset Classes & Strategies

×Funds for in-house use with sophisticated clients are now easily offered to retail investors as well

× Physical precious metals× Asset allocation strategies× “Alternative betas”

×ETFs serve as a wrapper for futures contracts that would otherwise have too high of a minimum size for retail investors

Page 19: ETFs - Past,  Present,  Future

19

Where Do We Go From Here

Page 20: ETFs - Past,  Present,  Future

20

Expansion of the Retail Market

×Everyone in the industry is waiting for the retail market to appear, but it will be harder than expected

×Four major preconditions to a robust retail ETF market in Europe

× Increased retail investor demand× Greater trading volume / visible liquidity× Greater transparency× Simple cross-border transactions within EU

Page 21: ETFs - Past,  Present,  Future

21

Expansion of the Retail Market: Investor Demand

×Need to make the case to individual investors for low cost and passive investment

× Who will be the UK’s Jack Bogle?

×A critical mass of advisers and other financial professionals looking for low cost vehicles

× Organic movement toward fee-based financial advice took decades in the US

× Regulatory pushes in Europe may accelerate the process(UK’s Retail Distribution Review)

Page 22: ETFs - Past,  Present,  Future

22

Expansion of the Retail Market: Greater Trading Volume

×OTC trading volume does not do much for retail investors

×Need to recruit a new sort of institutional investor, as heavy exchange traders and retail investors have a natural symbiosis in ETFs

× Make shorting ETFs easier× Movement toward ETFs as cheaper, easier,

and more flexible than other forms of beta exposure (futures, swaps, etc.)

×Moving trade volume onto the exchanges is a self-perpetuating process once it starts, as greater liquidity makes larger on-exchange trades easier, which in turn generates more liquidity

Page 23: ETFs - Past,  Present,  Future

23

Expansion of the Retail Market: Greater Transparency

×Apply MiFID to exchange-traded funds× Reveal all liquidity to all market participants× Help retail investors feel comfortable that the

playing field is level

×Retail investors want to know what they are holding

× Full portfolios published frequently and with little delay

×Synthetic replication ETF providers will have to win not just on cost and on tracking, but also have to match the openness

× Make collateral rules easier to find× Disclose collateral portfolios as well as index

portfolios× This information is already available to

institutional investors

Page 24: ETFs - Past,  Present,  Future

24

Expansion of the Retail Market: Cross-Border Transactions

×Liquidity makes ETFs a winner-takes-all competition

× Institutions will trade across borders for the best execution

× Retail investors need to be able to do the same

× This trend is already coming to fruition, as several retail brokerages offer fairly inexpensive trading throughout the EU

Page 25: ETFs - Past,  Present,  Future

25

Consolidation in the European ETF Marketplace

×This winner-takes-all competition for liquidity will drive consolidation in the ETF marketplace

× One or two “winners” will take the vast bulk of assets and trading volume for any given index to track

× Despite having lower assets and not much growth, many smaller funds will remain alive on assets from in-house customers

×Off-exchange distribution channels can not drive this consolidation

× Liquidity and low trading costs are the draw of the top funds, and they do not carry over to off-exchange distribution

Page 26: ETFs - Past,  Present,  Future

26

Product Innovation Will Continue

×New entrants in a more mature market can only compete on low costs or product innovation

×Plenty of new areas ripe for expansion× Fundamentally-weighted indices× Screened indices× Active ETFs× Funds of hedge funds× “Alternative beta”

Page 27: ETFs - Past,  Present,  Future

27