Dax ETFs: tracking or shaping the market?

The German ETF industry has grown rapidly in recent years. Xetra, which covers 91% of the German ETF market, now has 1,123 ETFs listed, compared to around 200 in 2006.

While much has been made of the impact of ETFs on individual portfolios relatively little attention has been paid to the potential impact of these products on the overall valuation of German stocks.

As the ETF industry in Germany keeps growing, at what point might they shape, rather than track stock market performance?

While there is no official data on the proportion of ETFs impacting major German stock market indices such as the Dax 30, figures on the growth of German equity ETFs suggest that they have become increasingly important.

According to German investment fund association BVI, 2015 has been a turning point for equity funds. Following four years of net outflows, equity funds finally recorded €21.1bn in new inflows, with the bulk of these being received towards the end of the year.  However, a closer look shows that among these new inflows, €14.9bn, more than 70%, were invested in ETFs.

One could argue that in relation to the overall market in equity funds, ETFs still constitute a minority. As of 2015, 12.2% of German mutual funds were ETFs, compared to 2.6% in 2006 (see table 1).

At the same time, German equities were the third most popular asset  class among European ETF investors in 2015, attracting more than €3.5bn, according to Lipper.
Meanwhile, the Dax remains the most popular index, with an annual turnover of €47.89bn in 2015, according to Deutsche Börse.

Table 1: Share of ETFs in German mutual funds

box out 2

Source: BVI, 2016

Consequently, while ETFs are still a minority of fund investments overall, the pace of growth in relation to the overall equity fund market, and their share of last year’s net inflows suggests a heavy concentration of passive investments in the companies which make up the Dax 30.

The ETF market is not just concentrated  in terms of asset class, but also  in terms of providers, with Black- Rock’s iShares currently accounting for almost half of all ETF assets in Europe, according to Lipper. In Germany, iShares’ assets amount to about 53% of all ETFs issued on Xetra, according to Deutsche Börse.

For investors, the bright side of the growing popularity of ETFs is that spreads for the 20 most liquid equity ETFs traded on Xetra have fallen from 39.74 basis points in 2003 to 5.64 basis points in 2015. On the other hand, the average spread of all ETFs listed on Xetra was 44 basis points in 2015.

The market data, then, suggests a challenge to fund selectors.

Jörg Schmidt, deputy head of Multi- Asset Management and head of Fund Selection Strategy at Union Investment, rarely uses ETFs and argues that they have contributed to distortions in valuation for certain sections of the stock market.

“If you look at what happened in August last year, when some major ETF providers sold off some of their class among European ETF investors in 2015, positions in in European equities because of outflows of stocks with large index weightings.”

Table 2: TOP 10 Reference Indices with highest trading volumes in 2015box out 1

Source: Xetra, 2015

Given the concentration of passives in certain companies, he believes that a lot of alpha can be found in other parts of the market. “For example small caps, which are much less covered by ETFs, actually performed very well throughout the same period,” he highlights.

“I believe it would be a big mistake to build up one’s asset allocation completely based on passive strategies,” Schmidt argues. “Active managers now have the biggest right to exist ever,” he concludes optimistically.

For others, the use of ETFs depends a lot on clients’ needs. At Feri, Florian Langner, director Investment Consulting and Manager Selection covers institutional clients
that are primarily invested in active mandates and hence uses relatively few passive investment products, whereas Robert Fragner, director Portfolio Management and head of Manager Selection covers the wealth and portfolio management side – where about one third is invested in ETFs – argues that in an active investment strategy, tactical and cost effective core positions can be covered through ETFs.  Fragner argues that in the context of an overall long-term investment with a relatively low turnover, tactical positions can be covered through ETFs.

Detlef Glow, head of Lipper EMEA Research, backs this position. “On the one hand the high number of similar products, for example ETFs on the EuroStoxx 50 or the S&P 500, improves competition among providers.

This results in an improved quality of index replication and the costs, in relation to management fees, are falling. “On the other hand, professional investors in particular, require a broad range of products reflecting different indices and strategies in order to implement their market view as precise as possible. In theory, investors could do
so whilst also relying on actively managed products, but in practice, this is far from straightforward.”

Nevertheless, Ulrich Rathmann, portfolio manager fund of funds at Acatis, remains wary. “I am not a massive ETF fan. We do have about 5%-10% in our portfolio and they can be handy in filling a gap if the perfect active fund isn’t readily available, but overall, I believe that they lead to market distortions and volatility or even flash crashes.”

“Prices are being pushed around arbitrarily and people senselessly buy baskets of stocks without any consideration of valuation,” he argues.

Rathmann is particularly sceptical of what underlies many ETFs; a number are based on synthetic, rather than physical replication, which means issuers enter into swap
agreements with investment banks that pledge to deliver the relevant index return in exchange for the return gained on the underlying assets the ETF reflects. Synthetic ETFs tend to be more prevalent on the commodities side, the trend for equity market ETFs is towards physical replication.

Overall, while most selectors appear to be cautious of the trend towards passives, it is a struggle to find a selector who does not own or recommend an ETF. According to Glow, the devil remains in the detail; investors should therefore be careful which index they track.

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