14 OCT, 2020
By Constanza Ramos
The attractiveness of ETFs have only increased since their inception in the late 1980’s, and it is understandable why. ETFs represent an easy way to introduce diversification within a portfolio, providing broad exposure to sectors or markets, while offering the investment industry’s lowest management fees. However, in our current economic environment, investors seeking returns and portfolio outperformance are looking at ETFs and wondering how the strategy will evolve. In this section we explore the future of ETFs alongside Amundi, HanETF, HSBC, iShares and State Street Global Advisors.
Recently investor interest in sustainability has grown exponentially, in fact in February this year EPFR data showed that ESG-aligned equity funds globally had witnessed growth of over €60billion in twelve months – while non-ESG equity funds had suffered outflows of almost three-times as much. We have seen this trend for sustainability reflected within the ETF market in Europe; in the first half of 2020 European ETF flows were close to flat overall but this hid almost €12billion in outflows from funds tracking non-ESG indices while inflows into ESG ETFs surpassed €11billion.
But why, and what next? There are a number of reasons for the growth of ESG, one being awareness of issues and a growing need for transparency, we also see increasing regulatory requirements for investors to consider ESG as part of their investment approach. However, perhaps the most influential reason lately is performance. It became very apparent during the market volatility this year that sustainable investment strategies offered strong performance.
2020 is the 20th anniversary of ETFs in Europe and over the last two decades these products have shaken asset management’s cage, gaining over $5 Trillion of assets.
ETFs and indexes Active ETF assets are currently small given the size of the overall industry, but growth is strong. Active ETF AUM has seen more than 2 years of consistent asset growth, reaching a high in January 2020 of $162 Billion across the 779 Active ETFs available globally. It’s evident that if high quality active managers could combine their strategies with the attractive qualities of ETFs then both the manager and investor could win – but a new solution is needed.
In 2019, the SEC approved a new approach to support the creation of non-transparent ETFs, opening the door for active managers to benefit from the distribution power of the ETF wrapper- and Europe is set to follow suit. But aren’t ETFs supposed to be transparent and track an index? We say no.
At HANetf we believe that ETFs are simply a wrapper and are not defined by the strategy they follow. Any liquid strategy or asset class – active or indexed - can be accommodated within the ETF wrapper which will then deliver that strategy to investors in the modern format they want.
The tremendous growth of ETFs, and the variety of new ideas coming to market demonstrates that advisers, model portfolio managers and end investors want a wide variety of tools, both active and passive, to help them meet their investment objectives, and they want them in an ETF format. Of course, ETFs are not a panacea for an underperforming active manager, but they do offer managers delivering real value the chance to rapidly extend their distribution and reach new types of investors.
When reflecting on the growth of passive investing, it is fair to say that it has been quite a journey. As the asset management industry has grown, client expectations have changed and the demand for low-cost, innovative solutions has increased. Beginning with “vanilla” products that tracked traditional benchmarks, passive investment vehicles have evolved to become more complex, tailored and cognisant of market trends. Alongside the “rise of passive”, sustainable investing is the most recent trend to reach asset management, as investors seek to capitalise on the favourable regulatory backdrop and shifting patterns of consumption. Empirically, we can see the substantial growth of sustainable investing as sustainable funds, collectively, now account for over $1 trillion of assets (Morningstar, 2020).
The Sustainable ETF space is quickly becoming crowded. From our perspective, future opportunities lie within sustainable smart beta. Smart beta is typically characterised as a systematic investment style that lies between active and passive management. Like passive investments, smart beta has seen extremely rapid growth in recent years, with multi-factor strategies in particular showing clear benefits of diversification and the potential to enhance returns across a variety of economic regimes.
Smart beta includes rules-based investment strategies that deliver exposure to risk premia, such as size, low volatility or momentum. As these individual factors perform differently in different economic regimes, multi-factor strategies manage the correlations between them to outperform across the cycle.
2020: Turning point in growth of fixed income ETFs
In the past 30 years, the growth of ETFs has mainly been due to the use of these vehicles as instruments for equity investments. However, as this product has evolved, increasing in transparency and accessibility, it has also become one of the most commonly used tools by institutional investors for accessing fixed income markets.
More specifically, both fixed income managers and multi-asset investors have identified ETFs as excellent instruments to ensure efficient exposure to different segments of the fixed income market, also helping them to build up diversified and liquid portfolios.
With the outbreak of the Covid-19 pandemic and subsequent economic crisis, we have once again witnessed a time of debate over the reaction and impact of fixed income ETFs in a situation of extreme volatility and strain. The main issue to assess was whether ETFs would stand up under the pressure of a heavily-traded market, and even more importantly, whether they would be responsible for exacerbating price drops on the underlying market.
Over the last 10 years, the growth of ETFs in Europe has largely been driven by allocation to broad Equity exposures, with ETFs that track indices such as the S&P 500, MSCI World and MSCI Emerging Markets indices swelling in size as investors consistently pour money into these instruments.
While Equity investors tend not to hedge their currency exposure, preferring to accept the embedded currency risks, recent large-scale FX events, such as the GBP devaluation following the Brexit vote and CHF appreciation following the abandonment of fixed exchange rate.
More recently, the sharp depreciation in USD and expectations that this could be a continued trend for the currency, has brought sharp attention to investors, as USD exposure makes up more than 60% of most global equity exposures. Therefore USD depreciation can have a material impact i.e. for EUR investors.
The other trend pushing investors towards hedged exposures is a reduction in the cost of hedging. The cost to hedge is made up of the interest rate differential and ‘dollar basis’. Both have substantially reduced in the last month as the Fed was forced to aggressively cut rates to combat the impact to economic growth of the coronavirus.
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