The exchange traded fund industry expects to see significant growth over the coming years as regulatory changes brought about by the RDR broaden the advice spectrum.
In the run-up to the RDR, some commentators predicted the changes would boost the ETF sector as independent advisers must consider a broader range of investments for their clients.
Ratings agency Moody’s and fund analyst Lipper forecast rapid growth in the ETF space, citing an increased focus on cost and the advancing maturity of the sector being among the reasons why these vehicles will increasingly appear on investors’ radar.
BlackRock, which owns ETF provider iShares, recently reported the global exchange traded product industry benefited from record-breaking inflows of $262.7bn across the course of 2012 and reached the milestone of US$2trn assets under management on 18 January 2013.
It says the industry took 19 years to reach $1trn in AUM, but only four years to double this, with demand spread across institutional, professional and retail investors.
In the UK, similar growth has been seen. The value of ETFs traded on the London Stock Exchange increased by 424 per cent over the past five years, rising from £25.8bn in 2007 to £135.2bn by the end of 2012.
Just over two months after the RDR came into effect, are UK retail investors allocating more to these passive vehicles?
AWD Chase de Vere head of communications Patrick Connolly says ETFs can be used to gain exposure to a wide range of asset classes in real time and with relatively low charges, which can be particularly appealing to investors who subscribe to the view that most actively managed funds fail to consistently outperform.
But he says ETFs are “generally little-used by investors” and are not recommended by many advisers.
Connolly says the products are typically seen as being more complex than open-ended funds, especially synthetic ETFs. These products do not physically own the underlying assets, can be difficult to understand and expose investors to an additional level of counter-party risk.
He adds the fact ETFs are not protected under the Financial Services Compensation Scheme is another reason for caution.
Connolly says: “We do use passive investments such as tracker funds in client portfolios but do not currently use ETFs. The charges may not be as cheap as they first seem for smaller investors or those who are rebalancing in their portfolio because stockbrokers’ costs need to be paid when buying or selling.”
Hargreaves Lansdown passives investment manager Adam Laird is more positive.
He says: “Anecdotally we have seen clients use ETFs to reduce costs in the portfolio and also to get exposure to areas where it is very difficult to find active managers.
“If you are investing in an ETF there are a lot of products which are under 0.5 per cent and some products are even around 0.2 per cent.”
Laird says investors appear to be changing how they view their overall portfolios and, with it, their opinion of ETFs. While they once considered themselves to be either active or passive investors, they now appear to be more willing to blend the two approaches and use a mix of products.
Specialist ETF advice firm WorldTrack founder Anthony Christodoulou thinks a combination of regulatory change, greater understanding of the products and more awareness of costs is encouraging investors and advisers to consider ETFs.
Christodoulou says: “The RDR environment is leading to a greater emphasis on cost and transparency and ETFs are a very cost-effective way to get access to asset classes.”
Christodoulou agrees with Laird that investors are now more willing to incorporate ETFs in their portfolios using a blended approach. He claims some are adopting an “all ETF” style which sees them maximise the cost and efficiency benefits by investing solely in the products.
IFA firm Dennehy Weller and Co managing director Brian Dennehy says growth in the ETF space has not been reliant on the RDR. He says there are certain opportunities you can only exploit through ETFs, such as certain types of equity incomes, currencies and commodities exposure.
Dennehy says: “Our exposure is mainly through equity income ETFs to gain currency exposure.”
Despite predictions of rapid growth from the ETF industry, there is little evidence in the UK that the products will be an immediate beneficiary of the RDR as concerns raised by advisers such as Connolly continue to weigh on investors’ minds.
But as the market looks beyond the typical open-ended funds that once dominated investors portfolios, it seems likely that awareness and use of ETFs will rise over the medium term.
As Moody’s says in its recent Global Asset Management outlook: “With a reluctance to pay for underperformance, retail investors have increasingly shifted allocations from actively managed mutual funds to passively managed funds. The use of passively managed products, including ETFs, will continue to rise.”