In the last decade the Exchange Traded Product industry has undergone a rapid transformation, becoming one the fastest-growing areas in the investment management industry.
To put this into perspective, global ETP assets under management stood at just under US$3trn (£1.9trn) at the end of June, reflecting an almost tenfold increase over the last 10 years.
More recently, it has been widely reported that global ETP assets have now exceeded those of the hedge fund industry, representing for many a significant landmark moment. Perhaps this is a good opportunity for us to consider why investors are using ETPs, what they are investing in, and the future for the ETP industry.
The innovation and adoption of ETPs is really a reflection of the growing influence of passive investing more broadly across the investment management industry.
This shift in investment philosophy is underpinned primarily by two things – the application of efficient market theory and the use of quantitative modelling in portfolio construction. Investors are now questioning whether active managers are able to consistently outperform their benchmarks and are invariably turning to passive instruments, such as ETPs, to provide consistent market risk-adjusted returns. So where do ETPs fit into this narrative?
Low costs, liquidity and transparency are often cited as being among the key drivers of ETP use. Given the current regulatory environment post-RDR, costs, in particular, are undoubtedly a key consideration for advisers and discretionary managers constructing model and bespoke portfolios in the UK.
However, to fully understand the importance of ETPs, one cannot ignore the investment access that they have provided. In many respects they are democratising the investment landscape, offering investors the opportunity to construct diversified portfolios, implementing strategic and tactical investment strategies across a number of different asset classes.
ETPs are being used as the building blocks in portfolio construction, their relative simplicity and flexibility having ensured they have become an integral investment tool for investors looking to execute on their investment goals.
ETPs are being used as the building blocks in portfolio constructionAccording to research conducted by ETFGI, as of the end of June 2015 there were 2,118 ETPs in Europe. Taking this vast universe of products into consideration, it is worth mentioning the distribution of ETP assets by asset class. Approximately 68 per cent of ETP assets in Europe provide exposure to equities and 21 per cent to fixed income. The significant allocation of assets to equity ETPs is largely indicative of traditional asset allocation models and the strong desire for index-based developed equity market exposure.
Of the top 10 ETPs in Europe by assets, eight are providing exposure to UK, US or European equity markets, accounting for 15 per cent of total ETP assets in Europe.
Interestingly, there has also been a noticeable increase in flows into currency-hedged equity ETPs in 2015, reflecting positive sentiment for international equities, but concern about the impact of currency exposure on total returns. This development is illustrative of the dynamic and solution-led nature of the ETP industry. Simply, there is an ever-growing universe of ETP investment solutions for investors to use to achieve their investment goals.
The fact that nearly 90 per cent of European ETP assets are exposed to equities and fixed income is not surprising – as stated above, this largely reflects the adoption of traditional asset allocation models.
However, looking at the bigger picture, we must not underestimate the influence of ETPs in providing access to other asset classes that were not readily accessible to both advisers and discretionary managers in the past. We are, for example, seeing increasing interest among the investment management community for alternative classes like commodities and currencies.
Commodity ETPs made up just over 7 per cent of total ETP assets in Europe at the end of June, despite relatively negative sentiment towards the asset class over the last few years.
Other thematic exposures and even such asset classes as currencies are being accessed today with ever-increasing frequency, which is illustrative of the important role ETPs are playing in multi-asset portfolio construction. Investors have a degree of freedom and choice that, prior to the invention of ETPs, was not there, and this level of access is changing the way in which people approach portfolio construction.
One of the biggest adopters of ETPs in the UK has been the discretionary management community. There has been an evident shift away from a bottom-up approach to portfolio construction to a top-down asset allocation-driven process, and we are seeing ETPs being used across model and bespoke portfolios, implementing both strategic and tactical investment strategies.
Mutual funds still make up the majority of assets across the investment management industry, but as investment philosophies and processes continue to shift alongside continuing regulatory developments, ETPs will continue to eat into mutual fund market share.
Growth in ETPs is expected to remain strong, with PwC forecasting global ETP AUM of US$5trn (£3.2trn) by 2020. The development of such new product types as currency-hedged and smart beta ETPs will continue to drive further use in the coming years as investors continue to take advantage of the vast universe of products that they have at their disposal.
Frank Spiteri is head of retail distribution of ETF Securities
Key points
Global ETP assets under management stood at just under $3trn (£1.9trn) at the end of June.
Low costs, liquidity and transparency are often cited as being among the key drivers of ETP use.
One of the biggest adopters of ETPs in the UK has been the discretionary management community.
