November 6, 2017

Monday Morning Memo: Alternative Strategies and ETFs

by Detlef Glow

ETFs have written a success story in Europe over the past 15 years, and the market does not yet seem to be oversaturated. Instead, the opposite seems to be true: the European ETF industry has witnessed a number of new players in the market, despite there being high competition in general in the European ETF market, and some market observers suppose that a number of ETF promoters are not at all profitable. That said, there is a sweet spot (the “smart beta segment”) where the competition is not that high and the pressure on management fees is quite low. Fund promoters can differentiate themselves there by using particular factors or by the way they structure the underlying indices for their ETFs.

The majority of the established ETF promoters have entered this arena by using factor-based indices,  calculated based on well-known market capitalization-weighted indices, e.g., only constituents of the respective market capitalization-weighted index are eligible for the given factor index. In contrast, ETF boutiques such as Wisdom Tree and First Trust offer ETFs based on indices they have developed. Earlier this year we witnessed active managers Candriam, Fidelity, and Franklin Templeton entering the European ETF market by offering active ETFs. During the summer we learned that JP Morgan is going to launch in Europe later this year a suite of ETFs based on hedge fund strategies, while Amundi (a well-established ETF promoter in Europe) launched on Euronext Paris at the beginning of this month an ETF with a market-neutral strategy.

Even though the launch of ETFs based on hedge fund strategies might be seen as a logical development for the market, the first promoter to offer hedge fund strategies wrapped in an ETF—Marshall Wace—struggled to gather investor interest in Europe. From my point of view this isn’t proof that these kinds of products are not in the favor of European investors. But the high complexity of these strategies requires great effort by the sales forces of the respective ETF promoters to make the new products a success. In addition, some investors and market observers doubt whether hedge fund strategies should be wrapped into an ETF, since an ETF has high liquidity (because it can be traded every second) while hedge funds offer in general much lower liquidity. Even liquid alternatives under the UCITS regulation have only daily liquidity. Another doubt about these products may be the bid/offer spread, since some products may lack transparency about the underlying index, which could lead to so-called risk price, i.e., a wider bid/offer spread set by the market makers of these products.

In this regard, I am not saying I am in general against having hedge fund strategies wrapped into an ETF. Only time will tell whether European investors are ready and willing to buy these kinds of products.

The views expressed are the views of the author, not necessarily those of Thomson Reuters.

Get In Touch

Subscribe