November 12, 2018

Monday Morning Memo:  Are lower fees leading to more innovation in the European ETF industry?  

by Detlef Glow.

With net inflows of 35.5 billion euros and with not one month of net outflows over the course of 2018 so far (as of September 30), it seems the environment for ETF promoters in Europe is still positive. Meanwhile, their active counterparts face struggles from the uncertainty in the securities markets. Some market observers would say that ETFs are also having a bad year, since the net inflows for 2018 are far below the net inflows of 2017. Even though that is correct, one needs to remember that not every year can be a record year. It is worthwhile bearing in mind that ETFs might yet enjoy higher inflows for 2018 overall than they did for 2016 or 2014 (two of the five years with the highest net inflows in history), if the current trend for fund flows continues.

Given these facts, it seems ETF promoters in Europe have a bright future. But, I would question whether that is really the case for all European ETF promoters, since the profitability of at least some of the ETF promoters in Europe is under scrutiny. We have witnessed in the past that even some of the ten largest ETF promoters were not at all profitable, and the margins are now under more pressure than ever. The costs to fulfill regulatory requirements are constantly increasing, while fees for “plain-vanilla” ETFs on the core indices are in a race to the bottom. Given all this, it is no surprise that ETF promoters are looking for new ways to enhance their earnings with modern portfolio management techniques such as securities lending or with the launch of so-called smart-beta ETFs. While securities lending is controversial in the investor community, using the factors as a basis for developing smart-beta strategies has become common. The good news for ETF promoters is that they can charge higher fees for smart-beta products and don’t have to worry so much about the competition, since a number of these strategies are at least in the details not comparable and are therefore not under so much pressure with regard to the fees promoters can charge. But it is still unproven whether these products, especially if they are offered by smaller promoters, can gather enough assets under management to boost the balance sheets of the promoters.

From my point of view, it is clear that the smart-beta segment will be one of the growth drivers for the European ETF industry, since this is a segment where we see a lot of innovation. But this also means we will witness a lot of liquidated products, since not all of these strategies will be successful. That said, I strongly believe the survivors will become mega sellers, since they will have proven that these strategies are able to deliver excess returns compared to their plain-vanilla peers. This also means that some of the (currently) small specialized ETF boutiques that only offer smart-beta products will have a good chance to become larger players in the European market.

The views expressed are the views of the author, not necessarily those of Lipper or Refinitiv.

Get In Touch