ETFs compete on more than just costs

This article is part of
Growth in Exchange-Traded Funds - April 2014

The latest salvo has come from Deutsche Asset & Wealth Management, with the launch of a range of low-cost db-X trackers with an all-in annual fee of 9 basis points.

The ETF market is maturing and there are an increasing number of ways providers are trying to set themselves apart from their competitors.

Overall, the ETF market remains buoyant: the February ETFGI’s Global ETF and ETP industry insights report showed flows into ETFs and ETPs rebounded in February, hitting $29bn (£17.4bn). This pushed overall assets within ETFs and ETPs to a new high of $2.44trn. Fixed income ETFs/ETPs were ahead, gathering $16.8bn with equity ETFs/ETPs gathering $10.2bn.

Although this would suggest an ETF market in rude health, the recent activity in the ETF sector has largely been around cost. The majority of advisers are using ETFs for the express purpose of driving down costs, so it makes sense that this is an important criteria, but the sector can often seem to be engaged in a race to the bottom. This is particularly true for ETFs based on the mainstream indices, such as the FTSE 100 or S&P 500, where there is a wide choice of providers.

However, Andy Clark, chief executive officer at HSBC Global Asset Management, says ETF providers can differentiate themselves in other ways: “If it were only about price, there would be a direct correlation between price and size, and that is not necessarily the case. Certainly, every basis points counts in the beta space, but there are differences in terms of physical versus synthetic replication, stock lending and index tracking. The decision-making is more complex.”

Physical replication appears to have won out against synthetic replication. According to data from Deutsche Bank, there is now €208.43bn (£172.57bn) in physically replicated ETFs in Europe, versus €91.17bn in synthetic replication and the gap is widening. Physical replication requires scale and BlackRock’s iShares range continues to dominate the market.

While it may not all be about cost, certainly many providers are now looking to higher-margin products to give balance to their businesses. The average total expense ratio (TER) of an ‘alpha’ ETF is 0.69 per cent, compared to 0.42 per cent for a ‘beta’-only product.

Mr Clark says that while the group has made a number of market-cap fund launches in the past year, the market is now well supplied and they are looking more towards ‘smart beta’-style strategies: “If you look at the institutional market, these type of strategies are already pretty big there. These re-cut the index to give different portfolio characteristics and might include economic scale indices, for example.”

At the same time, BlackRock registered the launch of two active US equity products at the beginning of April: the iShares Enhanced US Large Cap ETF and the iShares Enhanced Small Cap ETF. State Street Global Advisors has also launched a ‘Dividend Aristocrats’ series, based on the indices from S&P, which have proved popular.