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The fast grow

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James Smith reports that in just 10 years exchange traded funds have hit the $1trillion mark and the sector is still expanding rapidly with product providers looking to widen their scope

Exchange traded funds passed two significant milestones this year. At the start of 2010, ETFs passed $1 trillion under management globally and this year also marked 10 years since the first ETFs were launched in Europe.

Since their launch, the market has grown quickly and there are already more than 1,000 different ETFs offered by 37 providers and listed on 22 different exchanges in Europe.

Figures from BlackRock show that European assets under management are now in excess of $274bn and this has continued to grow at a blistering pace. In October, European ETFs saw net inflows of $7.9bn.

Most of this growth has come from institutional investors and growth in the retail area has been slow so far. However, there are signs that ETFs are finally gaining some momentum in the retail market and many people predict the RDR will add further impetus to this growth.

And although the growth of the retail market may have been slow so far, the development of new ETF products has been anything but slow. This year has continued to see rapid development in the ETF market as providers continue to innovate and evolve both the range of investments available through ETFs as well as the structure and design of ETFs themselves.

Looking at product developments this year, launches have largely focused on the most popular investment themes such as emerging markets and commodities.

In this area, ETF Securities is preparing a range of physically backed ETCs (exchange traded commodities) to list on the London Stock Exchange.

ETF Securities CEO Graham Tuckwell says this platform is intended to provide exposure to physical industrial metal without the need to purchase and store it directly.

He says: “These products will complement our existing offerings, which are priced off futures rather than cash market prices.”

Bond launches have also dominated, with db x-trackers adding to its credit vehicles and iShares registering a European first with a high-yield debt offering.
Perhaps more significant from the iShares stable this year is the group’s venture into swap-based ETFs tracking less mainstream markets.

Broadly speaking, there are two types of ETFs, with some using cash or full replication - which basically purchase all the underlying stocks in an index - and some synthetic replication using swaps.

In the latter, a counterparty agrees to match index performance and this method opened the ETF world to asset classes such as commodities and money markets, as it offers index returns without owning the underlying securities.

iShares has largely taken the physical route and its swap-based platform is focusing on areas where full replication is difficult under Ucits rules.

First to launch under this umbrella were Russia and India products, with the group using three counterparties and over-collateralising to minimise any risk on this front.

Axel Lomholt, head of product development for iShares EMEA, says: “This initiative reinforces our position as the market leader in one of the fastestgrowing areas of fund management. iShares remains committed to its physically backed ETF structure offering, which we believe continues to be the most effective and efficient way for investors to access mainstream asset classes and will always be our first option when launching products.”

BlackRock global head of ETF research Deborah Fuhr predicts the ETF sector will continue to develop as we see more products from traditional active managers as well as hedge specialists.

As new generations of products come to market, she says it is important to ensure investors understand their structures and mechanics where they deviate from the traditional open-ended, exchange-traded offerings.

Overall, she believes investors have adopted ETFs because we are in a back-tobasics environment since the credit crunch where transparency is prized.

Fuhr says: “We are at an important crossroads in the industry as we risk moving away from the product that has been embraced by retail and institutional investors.

“Now the industry accounts for over $1tn in assets, groups are working to find ways to put structured products, hedge fund and active mandates into ETFs and agreeing definitions for the various exchange traded vehicles is one of the growing needs in the industry.”

Following this line, active ETFs have also continued to gather pace in the US - although it remains just $2.11bn of the country’s nearly $800bn exchange traded market.

These only started life in 2008 and, unlike traditional passive ETFs, are run by managers taking active positions to generate alpha.

They are designed to combine the structural benefits of an ETF with traditional stockpicking and groups such as Pimco are becoming increasingly active in this sector.

Shishir Nigam, who runs an active ETF website in the US, says debate is split between those who feel these will be a big part of the industry’s push into a mutual fund dominated investment landscape and those that see them detracting from the structure’s passive roots.

He says: “The major players in the industry are not taking any chances. As of now, each of the four biggest ETF providers in the US has filings with the SEC that will allow them to launch actively managed product in future, if they have not already done so.”

The UK’s ETF industry is still years behind the US but this shows how the market is developing and where these products are heading if they do finally gain retail traction after the RDR.

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