“In terms of those replication methods, historically we were instrumental in the development of and are still strong believers in synthetic replication, especially for complex indices, such as in the emerging markets, where it definitely adds value for investors.
Depending on market conditions and investor appetite we have also developed a physical range where it makes sense, where the synthetic method does not bring enough value. In this method we use securities lending where it is appropriate, except on the fixed income side.
“Meanwhile, we do not use the sampling method, which is a statistical technique. We consider the trade-off between risk and return. As our primary goal is providing products that perfectly track the index, we have to make sure the tracking error is very small. We do not want to get to a situation where the index and the ETF diverge significantly.”
Overall, Mr Llinas believes the strength of the proposition will help secure market share as a growing number of retail investors look for cost-effective investment options following the retail distribution review in the UK and other regulatory and legislative changes across the rest of Europe. With a broad trend of advisers moving from a commission-based to fees-based remuneration model, ETFs are quickly becoming a more-often-used option for canny advisers and their clients.
“Our business is still mainly institutional, but we anticipate the retail aspect will grow,” Mr Llinas confirms. “While I would estimate that at the moment retail clients make up less than 10 per cent of total business, if you look at the US market and the recent regulatory change in Europe, we would expect the proportion to rise to 50 per cent one day. It will be a slow process, but it is a reality that will come to pass eventually.”
As for the future of Lyxor ETF in general, Mr Llinas anticipates further development on the fixed income side of the business, as well as in some other asset classes to ensure breadth and depth of coverage for investors. Indeed, the company launched further fixed income funds this year, with plans to perhaps develop the range to include countries outside Europe. Meanwhile, on the equity side there is also an ambition to extend the global reach of the offer, including in depth exposure to emerging market countries as well as frontier markets for which the underlying liquidity is good enough. There is also a real interest in pursuing “smart beta” vehicles.
“For us smart beta means the ability to propose indices that are not weighted in the classic way, which is to say by market capitalisation or country, but rather are weighted by risk,” Mr Llinas explains. “We are proposing new ways of allocating risk budgets in a basket of assets. This initiative is an innovative idea for the market and it is as yet unclear whether it will be a massive trend and end up replacing traditional market-cap weighted indices, but it is definitely a centre of interest for clients.”
