More sophisticated methods of passive investing are likely to boom as part of the “next generation” of exchange-traded funds (ETFs), which pass a UK milestone this week.
Experts have said more complex ETF products will be the focus of future launches and are set to match the prominence of more simplistic funds that simply track a major index, such as the FTSE 100.
The comments come after the 15th anniversary of the first ETF to list on the London Stock Exchange on April 27 2000 – the iShares FTSE 100, which has since been renamed the iShares Core FTSE 100 Ucits ETF and has £3.8bn of assets.
The large size in just this one ETF is reflected more broadly across the sector, which grew from £3.9bn turnover in 2004 to £185.8bn turnover in 2014.
But while the focus has been on what could be deemed ‘standard’ ETFs, more bespoke investments are likely to be captured by ETFs in a much larger way.
Hector McNeil, co-chief executive of WisdomTree Europe, said he thought there would be a “natural shrinkage of common core products” as “the next generation of ETF” develops.
New-style ETFs include something dubbed ‘smart beta’, a passive vehicle that has an active skew from the outset.
Such a fund might, for instance, equally weight stocks in the index it tracks, or even track a bespoke index created by an index provider.
A sign of this growing area of the market is the collaboration between Lombard Odier Investment Managers and ETF Securities, which have partnered to offer a range of smart beta government and corporate fixed income ETFs.
These vehicles invest in the debt of companies or governments based on their ability to pay back creditors, rather than taking the approach of a conventional fixed income ETF which would have the greatest exposure to the company or government with the largest amount of debt.
Mark Weeks, chief executive officer of ETF Securities, expects more of these collaborative endeavours in the next few years as passives become “a bigger slice” of the investor pie.
“A lot more asset managers are coming to market and extending their offerings to include passives,” he said. “Some will try to do it by themselves, but there will be a growth of collaborations.”
However, while Mr Weeks expects ETFs to be provided by a broader range of companies, he does not see a business launching that focuses solely on ETFs given “all the major bases have been covered”.
Another area of potential development in the ETF market is fixed income.
Tim Huver, ETF manager of Europe for Vanguard, notes the use of ETFs is continuing to evolve and is becoming less of a short-term tactical trade for investors and more of a longer term buy and hold. As this trend develops, so does the potential for fixed income ETFs and multi-asset ETFs.
Also, while the UK has been a major destination for ETFs in terms of listing, it was only last month that China Construction Bank International launched the first UK-domiciled ETF.
Hazell Hallam, PwC UK ETF leader, said, “This is a start of a trend of how the UK ETF market will grow”.
Until now ETFs have been domiciled in Dublin and Luxembourg, but the UK’s dominance in ETF trading is making it a contender.
