Europe finds plenty to like about ETFs

Tom Lydon of Global Trends Investments looks at how European ETF market growth has overtaken the US

The US has been a leader in ETFs for years, enjoying steady growth in both assets and the number of products offered. While the US ETF market continues to grow, it now lags behind Europe in terms of the number of funds listed. 

According to BlackRock’s monthly review of the ETF industry, at the end of January 2010 the European ETF sector had 896 ETFs from 34 providers with assets of $217.9bn. Compare that to the US ETF industry, which had 791 ETFs from 28 providers and $665.4bn in assets in the same time period.

It is stunning growth, considering that the European ETF industry was only born in 2000, compared with the US market which started in 1993. 

The number of products in Europe and the assets accruing in these can be seen as an opportunity. On one side, as European investors learn more about ETFs, they have got a range of choices when it comes to fund selection. On the other side, the relatively low assets held in these ETFs can be viewed as a growth opportunity for providers.

Growth in Europe’s ETF industry can be attributed to several factors. One of them is different rules. The European Union’s Undertakings for Collective Investments in Transferable Securities (Ucits III) enables ETFs to use derivatives more actively, so providers have been able to cover a wide range of areas with the products. This has allowed the creation of funds that track money market indices, credit derivative indices and others, according to a paper by JP Morgan. 

A cautious approach

The US tends to be a little more cautious on new launches, especially when it comes to first-of-their-kind funds. It took years to get actively managed ETFs approved and launched, and the first physically backed palladium ETF has only been launched recently, after being in demand for years. Meanwhile, Europe has a couple of physically backed palladium funds, including the ETFS Physical Palladium and ZKB Palladium.

There are also more providers in Europe. BlackRock’s iShares, the global leader in ETFs, is the top ETF provider on the continent. Lyxor Asset Management, db x-trackers and Credit Suisse Asset Management follow suit. Providers are crossing the pond, too. US issuers PowerShares and State Street also have listings in Europe, while European provider ETF Securities now has US listings.

Another factor in the growing popularity of ETFs is the benefits they offer to anyone on any continent. The global market crisis has altered the way people view money, the markets and how they invest. Mutual funds, with their once a day trades, high fees and lack of transparency, are no longer products investors feel like they should have to contend with in order to have a chance to make money in the markets.

Burned by huge losses in their portfolios, investors are also no longer content to have some unseen entity determining the success or failure of their portfolios. They want to know what they own, they want to have the power to determine when they buy and when they sell and they don’t want to pay a lot of money for the privilege. A 2009 survey by the EDHEC-Risk Institute found ETFs are the preferred indexing instruments among institutional investors in Europe, thanks to liquidity, transparency and cost.

The advantages of ETFs

Transparency is among the many benefits ETFs offer investors. Any minute of any day, if an investor wants to know what an ETF holds, and in what proportion, all one has to do is visit any number of financial sites to find out. The ability to trade intraday also sets ETFs apart. Unlike mutual funds, which only trade once at the end of each day, ETFs trade throughout the day just like a stock. If a fund is plummeting the investor can get out – there is no need to wait until the market has closed.

The diversified exposure that ETFs offer is also of great appeal to investors. ETFs are baskets of stocks - some have just 25 components, others have hundreds. Whenever you purchase an ETF, you are instantly diversifying your portfolio with dozens or hundreds of stocks. 

ETFs are inexpensive and generally do not have an active manager because most track indices. There is no need to pay someone to pick stocks. These funds also outperform mutual funds. It’s incredibly difficult to consistently beat the market and if it was easy, every mutual fund would be doing it. But the fact is even the industry’s best and brightest cannot do it consistently. If you cannot beat the market, why not just buy the market?

In terms of risk, ETFs are low down the scale. When there are two or three very promising companies in a sector, how do you choose which one to invest in? With ETFs, you can invest in all of them.  By investing in a few dozen stocks that represent a sector, instead of trying to pick one or two winners in a sea of hundreds, the risk is spread around instead of concentrated on one company that could do very well – or very, very poorly. 

Tom Lydon is president of Global Trends Investments in the US