ETFs march on as costs fall further

Passive investments have always been put forward on the strength of their low charges and transparency, and this emphasis has only increased as active mutual funds have adopted a stronger focus on reducing costs and fees, further fuelling the active versus passive debate.

Nik Bienkowski, co-chief executive at WisdomTree Europe, notes: “Overall, the market is moving towards greater transparency. Generally costs in the ETF market have been coming down and it’s a good thing for investors. At some stage, though, it will reach a point where it can’t go much further as the ETF providers have to make a profit.”

Simon Klein, head of exchange-traded product distribution and institutional mandates for Europe, Middle East and Africa at Deutsche Asset & Wealth Management, says 2014 was a big year for ETF fee reductions, but that as we move into 2015 the focus is more on product innovation.

That said, he adds: “With the cost of investing in ETFs falling over the last two years or so – on some benchmarks quite dramatically – ETFs have become much more competitive in relation to other methods of taking passive exposure.

“This year, especially, we’re having more discussions with large investors who would traditionally have used either futures or an index fund to take their passive exposure, but who are now considering ETFs instead. This is partly because the costs of using ETFs have fallen so much, but also because the costs of using alternatives, like rolling futures contracts, has gone up.”

In terms of macroeconomic effects on the development of the industry, product innovation has increased with the rise of smart beta, currency hedging, fixed income and property ETFs.

Mr Klein points out that the US equity market has continued to deliver solid returns for investors, with the strengthening dollar also helping those invested in dollar-denominated funds.

But he adds: “With interest rates remaining low, and with the effect of quantitative easing kicking in, European equity markets have performed well so far this year, while emerging market equities are still volatile and are refusing to move to a sustained upward trend.”

Meanwhile, Mr Bienkowski highlights the growing trend for currency-hedged ETF products that look to offset the impact of foreign exchange movements as monetary policy and economic growth diverges across the main markets.

He points to European equity ETFs that hedge currency exposure into dollars. “These products hedge that currency exposure so you get the exposure to the change in the price of, for example, US equities, and neutralise any changes in the US and euro exchange rate, which can be a good or a bad thing.

“European equities have been popular in past few months given quantitative easing, so it would therefore be a positive to invest in European equities, but it can result in the currency depreciating against the US dollar.

“If European equities go up 20 per cent but the euro falls 10 per cent against the dollar, then as a US investor you’ll have only earned 10 per cent, but in the hedged-currency ETF it would be the same as if they were a local European investor.”

While these types of products have developed on most major currency pairs, Mr Bienkowski notes the ETF products that have the most currency-hedged assets are Japanese equities, where the yen has been depreciating against both the euro and the dollar.

“Currency hedging has been a very topical theme at the moment, as it is being driven by these large currency fluctuations and volatility in the major currency pairs in the past few years,” he says. “Because of that huge volatility, foreign exchange hedging is becoming a huge theme in the ETF space.”

Mr Klein notes other product development themes appearing in 2015 include an increased focus on fixed income ETFs, including higher yield corporate bond indices, and the use of alternatively-weighted indices that can fall under the ‘smart beta’ moniker.

“We may see a focus on alternatively-weighted fixed income investments,” he says. “We’re also seeing investors look to dividend-weighted equity ETFs as an alternative to fixed income, given that yields are so low in the fixed income market.”

Nyree Stewart is features editor at Investment Adviser

Expert view: active vs passive

Ben Horsell, head of marketing and product director at Lombard Odier Investment Managers, says:

“When I look at this debate, ultimately there is a place for passive and there is a place for active. Clearly what investors are frustrated with are those active funds or active strategies that just haven’t been doing what they set out to do, and that’s where you basically have a fund tracking a benchmark.

“We think there’s certainly a place for passive, [and] we think there’s certainly a place for active, and in particular high-conviction active.

“What we think is the issue is that quite often investors, when they buy passive, aren’t always aware of the risks they’re taking in the index that they’re buying.

“I think that’s where we’re trying to be a little more focused on making sure we really look at what the starting point is for investors, and making sure that makes sense in terms of how they’re trying to get exposure to different asset classes.”