ETF and indexing conference

The ETF market continues to burgeon with assets hitting all time highs and new product structures entering the arena. With expanding choice, investors need to consider which ETFs are most appropriate. Emma Dunkley reports

At a time when many investment vehicles were adversely affected by the economic downturn and the collapse of Lehman Brothers, ETFs were burgeoning through the latter part of last year. Speaking at the ETF and Indexing Investments Europe 2009 conference, Barclays Global Investors global head of research Deborah Fuhr explained some of the benefits of these vehicles. She said: “ETFs are transparent, provide instant diversification to a benchmark, while retail investors can buy one share and get the same economies of scale that pension funds find attractive.”

The ETF market in the UK looks set to shift towards a fee-based structure, similar to the framework in the US, following the Retail Distribution Review (RDR). Fuhr said the Financial Services Authority’s review found 85% of independent financial advisers are multi-tied to a bank or insurance company. She added that with the implementation of the RDR, IFAs will have to say if they are truly independent, and explain why they are recommending more expensive products to customers over more cost efficient ETFs. 

Elaborating on structure, Fuhr said investors need to be aware of how new products coming to market are constructed. She said: “Some people are surprised that some commodity products are structured as partnerships, while others don’t realise that some products have an exchange-traded note structure.” She added that investors therefore need to be aware of structure, domicile, and tax when selecting which ETF to invest in. 

In terms of tax, she said non-US investors buying US domiciled ETFs suffer an amount of withholding tax on income, unless the investor has filed with the US. “However, if you hold a European Ucits fund, there’s withholding inside the fund, but no withholding on payments going out, so that’s the reason Ucits structures are more tax efficient for investors.” As a result, investors in Latin America and Asia tend to prefer Ucits wrapped ETFs to US domiciled funds. 

Risk and volatility

Also speaking at the conference, iShares head of sales strategy Europe Nizam Hamid said the risk landscape has shifted, changing dramatically by the end of 2008 due to significant volatility across all asset classes. He explained the challenge has been finding out-performance, which few active funds managed to achieve in relation to their benchmarks in 2007. Conversely, he said ETFs have performed in line with their benchmarks, less the total expense ratio (TER). 

The ETF space has also evolved, developing with an increasing level of complexity in terms of structure, as exemplified by multi-swap based products, hedge fund ETFs and active indices. Hamid said: “In the changed risk environment, there has been a turn to ETFs as the main choice to implement ideas across asset allocations, offering consistent returns with controlled risk.” Yet he added that ETFs should not become more complex as the market develops. 

Look before you leap

BNP Paribas EasyETF head of product development Danièle Tohmé-Adet similarly explained that ETFs are not as simple as people think. She said: “There are lots of areas that should be checked before you invest, especially because the jurisdictions are different, the management fees could be different, and behind the management fee there is the issue of tracking error.”

She said EasyETF uses a mixture of both cash-based and swap-based ETFs, depending on the underlying. For example, she said a cash-based methodology is used for an ETF where there are a limited number of European stocks, while synthetic replication is used when there are too many components in an index, or if there are fiscal concerns. She said: “A swap replication in this sense can reduce the costs. You can also monitor your counterparty risk in a different way with open architecture, by doing an auction for every swap.”

Tohmé-Adet also addressed the issue of securities lending, which was brought up by a delegate with regards to cash-based ETFs. She said lending is not a problem, although this depends on whether the funds use collateral. She added: “Most issuers do have collateral for lending, but you still have to look at the level of collateral used and what the collateral is.”