July 2, 2018

Monday Morning Memo: Market Overview—Factor-Investing ETFs (May 31, 2018)

by Detlef Glow.

Factor-investing ETFs (the so-called smart beta ETFs) have been seen for a few years as one of the main drivers of future growth in the European ETF market, since they are innovative products that suit the needs of many investors. These kinds of products get a lot of attention from market observers and are also a topic of many discussions and panels at numerous asset management conferences. But even though there is a lot of noise around factor-investing ETFs, the open question is whether investors will buy into these concepts. Here we attempt to shed light on the wider market structure of the European ETF segment and take a closer look at the assets under management in factor-investing ETFs to determine these products’ relative success.

There were 2,481 instruments (primary funds and convenience share classes) listed in the Thomson Reuters Lipper database at the end of May 2018 as ETFs that had a sales registration in at least one European country. A total of 284 of these products (150 primary funds/134 convenience share classes) could be considered as ETFs using a non-market-weighted or factor-based investment approach to determine their portfolio holdings.

With regard to the overall number of products, it was not surprising that equity ETFs (€475.9 billion) held the majority of the assets, followed by bond ETFs (€155.8 billion), commodity ETFs (€21.0 billion), “other” ETFs (€6.6 billion), money market ETFs (€3.4 billion), mixed-asset ETFs (€0.7 billion), and alternative UCITS ETFs (€0.4 billion).

While in general ETFs in Europe enable investors to invest in nearly all asset classes, the universe of factor-based products is rather narrow; it offers investors the ability to invest in only three asset types: equities (€21.4 billion), bonds (€0.4 billion), and commodities (€0.3 billion).

Graph 1: Assets Under Management by Asset and Product Type, May 31, 2018 (Euro Billions)

Market Review - Factor-Investing ETFs

Source: Thomson Reuters Lipper

With regard to the overall market pattern, it was not surprising that the assets under management at the ETF level at the end of May were highly concentrated. Only 158 of the 2,481 instruments held assets above €1.0 billion each. These products accounted for €407.7 billion or 61.43% of the overall assets in the European ETF industry.

The segment of factor-investing ETFs also showed high concentration, even if one looks at the aggregated portfolio level. Only six products held assets above €1.0 billion each, accounting for €7.9 billion or 36.57% of the overall assets under management in the segment. Six funds held assets between €0.5 billion and €1.0 billion (cumulative €3.7 billion), while another 29 funds held assets between €0.1 billion and €0.5 billion (cumulative €6.9 billion). The majority of factor-investing ETFs (82) held assets between €0.01 billion and €0.1 billion (cumulative €3.0 billion), while another 27 products held assets below €0.01 billion (cumulative €0.2 billion).

Even though factor-investing ETFs in general are more profitable for fund promoters than “plain-vanilla” products because of their higher management fees, the smaller products in terms of assets under management especially may be merged or liquidated, since they would seem to be unprofitable for the promoters. That said, a fund closure is not entirely negative, since fund promoters must continually bring innovations to market to see whether they are strategies of interest to investors.

Graph 2: Factor-Investing ETFs’ Market Share by Assets Under Management, May 31, 2018 (Euro Billions)

Market Review - Factor-Investing ETFs

Source: Thomson Reuters Lipper

But the lack of assets under management in some factor-investing ETFs can be a threat for investors; they may want to invest exactly in the strategy offered by a particular ETF and will not be able to find a proper replacement if their ETF is liquidated. This means that very small factor-investing ETFs especially face a “hen or egg” situation; investors may want to invest in a specific strategy and may even tolerate anticipated (book) losses if the promoter liquidates or merges the ETF, but they may not be able to find another suitable fund for their investment strategy.

Especially in the bond sector, many investors are looking for innovations. They don’t want to invest in market-capitalization-weighted indices, since this means they would have to invest the largest amount of their money in bonds of issuers with the highest outstanding debt. For this reason I would expect the segment of factor-investing strategies in general to continue to grow.

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

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