Editorial & Advertiser Disclosure Global Banking And Finance Review is an independent publisher which offers News, information, Analysis, Opinion, Press Releases, Reviews, Research reports covering various economies, industries, products, services and companies. The content available on globalbankingandfinance.com is sourced by a mixture of different methods which is not limited to content produced and supplied by various staff writers, journalists, freelancers, individuals, organizations, companies, PR agencies Sponsored Posts etc. The information available on this website is purely for educational and informational purposes only. We cannot guarantee the accuracy or applicability of any of the information provided at globalbankingandfinance.com with respect to your individual or personal circumstances. Please seek professional advice from a qualified professional before making any financial decisions. Globalbankingandfinance.com also links to various third party websites and we cannot guarantee the accuracy or applicability of the information provided by third party websites. Links from various articles on our site to third party websites are a mixture of non-sponsored links and sponsored links. Only a very small fraction of the links which point to external websites are affiliate links. Some of the links which you may click on our website may link to various products and services from our partners who may compensate us if you buy a service or product or fill a form or install an app. This will not incur additional cost to you. A very few articles on our website are sponsored posts or paid advertorials. These are marked as sponsored posts at the bottom of each post. For avoidance of any doubts and to make it easier for you to differentiate sponsored or non-sponsored articles or links, you may consider all articles on our site or all links to external websites as sponsored . Please note that some of the services or products which we talk about carry a high level of risk and may not be suitable for everyone. These may be complex services or products and we request the readers to consider this purely from an educational standpoint. The information provided on this website is general in nature. Global Banking & Finance Review expressly disclaims any liability without any limitation which may arise directly or indirectly from the use of such information.

ETFs in 2012 and what we will see in 2013

Ian Webster, EMEA Managing Director, Axioma
The beginning of 2013 has seen the ETF industry taking a look back. The occasion for this nostalgia is the 20th anniversary of the launch of the SPRDR  S&P 500 ETF by State Street Global Advisors. Known by its ticker symbol SPY, the ETF began trading on 29 January 1993. Looking back, the launch of SPY was the starting point for a series of events that have fundamentally changed asset management. From this single product there are now thousands of exchange-traded products listed worldwide with combined assets under management of around $2 trillion.Ian-Webster

As the ETF industry takes a look back and quite rightly congratulates itself on the revolution that it has created, I want to explore what might be in store for the ETF industry in the future.

Projections about the ETF industry often begin by questioning whether the industry is running out of steam. Can the industry’s growth last?The starting point for this look forward is an unequivocal statement that the ETF industry will continue to grow. When we look back in another 20 years,we will see the continued remarkable rise for this market.

What drives this confident prediction? Particularly when 2012 saw the ‘shake out’ of a number of products from the market, with ETFs that hadn’t gathered sufficient assets being closed. Some investment houses retreated from the market altogether. Despite these challenging conditions, there was continued asset growth. For instance,AuMhas risen from just over $1.5 trillion at the end of 2011 to $2 trillion today. This indicates that while the‘shake out’ of the industry is likely to continue – not every product or investment house will succeed –assets will continue to rise for the foreseeable future.

Let’s look at two drivers for this growth in a little more detail: transparency and innovation.

The desire for transparency comes in two forms: what am I buying? And how much does it cost?

In response to the first question, 2012 marked the beginning of regulatory pressure: swap-based versus replication ETFs, market volatility, the use of derivatives– all were questioned by regulators. 2013 has begun with lawsuits from investors for Blackrock and State Street focusing on their securities lending business. While regulatory pressure could potentially limit the market’s growth, I think it should be viewed as a sign of the ETF industry’s increasing importance to the financial sector – and with that importance comes increased regulatory and market focus.

Investors will continue to seek complete transparency with regards to the vehicles in which they invest. For example, knowing whether a product is swap-based, an optimized replication of the index, or a complete replication of the index is important;the returns profile for an ETF tracking the same index using different methodologies might look very similar, but the risk profile will be very different. Clearly the counterparty is important for the swap-based product, while the quality of the optimization is vital for the optimized replication product.

Fee transparency will also be part of the picture. Expense ratio is the most visible cost measure that is used in the ETF market, but as we’ve seen with the lawsuits concerning securities lending the costs, as well as revenues made by the providers, it is not always fully transparent. I predict that in 2013 the industry will come under increasing pressure to develop a standardized way of tracking the full and true cost to any investor of owning an ETF.

The costs seem to break into two categories: (i) the fees that the manager can charge and(ii) the fees that the index provider can charge.

Asset management is and always has been an extremely competitive industry. Many low cost providers have succeeded, while many of those charging a premium have also been very successful. Investors seem comfortable making a choice between the two.

However, the cost of the index to the ETF provider is far less transparent – Vanguard shocked the industry by switching from MSCI to a combination of FTSE and CRSP;iShares has indicated that it is reviewing its index contracts, while regulators are considering its request to ‘self-index’ (i.e. produce products from indices that it has produced itself).

To date, the index industry has not been as competitive as the asset management industry; fees are not as transparent and the end investor doesn’t have the opportunity to switch index. The provision of indices to the ETF industry will be a very hot topic for the coming years.

While investors and regulators are focusing on transparency, the product sponsors will continue to focus on innovation. This innovation is likely to come from two main areas: strategy indices and active funds,with continued progress being made on alternative asset classes.

Looking at the strategy indices in more detail, the ETF industry has seen a series of innovations that center on the simple question of whether market capitalization indices are the most effective way to invest. As Jim O’Neill, the chairman of Goldman Sachs Asset Management stated, market capitalization-based indices “overweight what is overvalued, and underweight what is undervalued”.

There are numerous new approaches to indexing: fundamentally weighted, equal weighted, GDP weighted, market neutral, factor based, risk parity, and low volatility to name a few. Not all have made it to the ETF world, but you can be sure that the index creators are all marketing heavily to the product sponsors.

What these products all have in common is that they take a systematic approach to a specific strategy. Take, for example, the low volatility products that are available as ETFs: this approach to investing has been available in the institutional market as an active strategy for a number of years. What has happened over the past few years is the active approach has been standardized and packaged as an index.

So, one of the important aspects of ETF product innovation is that the cost to the investor is continuing to be squeezed – what was once an active strategy with active fees becomes a passive strategy with passive fees.