The European ETF industry 15 years on
The ETF industry has started its 15th year strongly, with total assets under management up 27% vs. the end of 2014, reaching €460bn. However, European ETF market flows were moderate in April 2015 after a very strong Q1 2015 with net new assets over the month amounting to €4.5bn, -16% below the one-year average.
The debate between the merits of active and passive management has been a major issue throughout the first half of 2015, looking set to continue as active managers are increasingly being asked to justify their ability to deliver value for money through strong returns.
Boston Consultant Group (BCG) noted that passive mandates and ETFs had grown from $3trn to $10trn in assets under management between 2003 and 2013, and BCG expects this market segment to continue to grow healthily. At Lyxor, we see a number of reasons for this trend. First, active managers continue to underperform their benchmarks in aggregate. According to our internal research, only 21% of active funds on average outperformed their benchmark over the last 10 years and the evidence also shows that there is little persistency in performance over time. Managers that beat the benchmark in one year have a poor chance of doing the same the next year.
Passive funds, including ETFs, also have a clear cost advantage against active funds, leading many investors to decide that they would prefer to track an index rather than to try and beat it. Passive funds’ costs are relatively low and have been steadily decreasing.
Furthermore, passive funds now offer access to a broad range of asset classes and with a great degree of granularity, offering investors significant choice. They are typically highly diversified, giving wide access to individual market segments and a good choice for investors looking to gain exposure to unfamiliar markets.
The development of smart beta—investment strategies, codified as indices, easily replicated in a systematic, transparent method—is also an increasingly important phenomenon.
Smart beta is expanding the traditional definition of passive investing, in a way that offers investors a valuable new tool. Various types of portfolio strategy traditionally undertaken by active investment managers can now be replicated efficiently and at low cost via smart beta indices. In other words, passive funds are increasingly being used to give exposure to strategies that were historically offered only in an active format.
To some extent, smart beta is also likely to replace some of investors’ traditional allocation to passive funds which simply track indices weighted by market capitalisation. The utilisation of risk factors is also an important development as they help us understand the performance of equities and other asset classes, and an increasing number of smart beta indices offer exposure to individual risk factors. There are other popular types of smart beta index, including those focusing on the reweighting of index constituents, on particular investment styles or on specific risk outcomes, such as minimising volatility. Smart beta has its roots in financial theory and in quantitative fund management and therefore managers need to have a solid research base and expertise in developing quantitative investment and index solutions.
The overall size and growth rate of the smart beta market is quite hard to measure: first, because of the lack of consensus on a definition; second, because a lot of sizeable smart beta mandates are managed internally at large pension plans and sovereign wealth funds, which typically provide limited disclosures.
At Lyxor, we manage portfolios based both on carefully selected third party indices and on proprietary index strategies, developed by our quantitative research team. We have already witnessed huge growth in demand for these strategies; at the end of 2014 we managed over $13bn for clients in such strategies, up from $1.6bn in 2010, across both equity and fixed income, via segregated mandates, index funds and ETFs.
We are also seeing plenty of indicators that the growth of smart beta is set to grow throughout the investment industry. In April 2015, Lyxor’s research department estimated that assets in what it calls smart beta exchange-traded funds (ETFs) had reached €10.4bn in Europe. European smart beta ETF inflows have been very strong so far in 2015. Net new assets in the first four months of the year were €2.3bn, more than half of total inflows of 2014. And total smart beta ETF assets were up 44.8% when compared with the 2014 year-end total. European smart beta ETF assets have tripled since the end of 2013 and we feel this number will only continue to increase.
Marlène Hassine is head of ETF Research at Lyxor AM