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.
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.
Airbus CEO urges trade war ceasefire, easing of COVID travel bans
By Tim Hepher
PARIS (Reuters) – The head of European planemaker Airbus called on Saturday for a “ceasefire” in a transatlantic trade war over aircraft subsidies, saying tit-for-tat tariffs on planes and other goods had aggravated damage from the COVID-19 crisis.
Washington progressively imposed import duties of 15% on Airbus jets from 2019 after a prolonged dispute at the World Trade Organization, and the EU responded with matching tariffs on Boeing jets a year later. Wine, whisky and other goods are also affected.
“This dispute, which is now an old dispute, has put us in a lose-lose situation,” Airbus Chief Executive Guillaume Faury said in a radio interview.
“We have ended up in a situation where wisdom would normally dictate that we have a ceasefire and resolve this conflict,” he told France Inter.
Boeing was not immediately available for comment.
Brazil, which has waged separate battles with Canada over subsidies for smaller regional jets, on Thursday dropped its own complaint against Ottawa and called for a global peace deal between producing nations on support for aerospace.
Faury said the dispute with Boeing was particularly damaging during the COVID-19 pandemic, which has badly hit air travel and led to travel restrictions or border closures. He expressed particular concern about widening bans within Europe.
“We are extremely frustrated by the barriers that restrict personal movement and it is almost impossible today to travel in Europe by plane, even domestically,” he said.
“The priority no. 1 for countries in general is to reopen frontiers and allow people to travel on the basis of tests and then eventually vaccinations.”
The comments come as businesses increase pressure on governments to reopen economies as coronavirus vaccine roll-outs gather pace across Europe.
France has defended recently introduced border restrictions, saying they will help the government avoid a new lockdown and stay in force until at least the end of February.
Germany installed border controls with the Czech Republic and Austria last Sunday, drawing protest from Austria and concerns about supply-chain disruptions.
Berlin calls the move a temporary measure of last resort.
Poland said on Saturday it had not ruled out imposing restrictions at the country’s borders with Slovakia and the Czech Republic due to rising COVID-19 cases.
(Reporting by Tim Hepher; Editing by Kirsten Donovan)
Why a predictable cold snap crippled the Texas power grid
By Tim McLaughlin and Stephanie Kelly
(Reuters) – As Texans cranked up their heaters early Monday to combat plunging temperatures, a record surge of electricity demand set off a disastrous chain reaction in the state’s power grid.
Wind turbines in the state’s northern Panhandle locked up. Natural gas plants shut down when frozen pipes and components shut off fuel flow. A South Texas nuclear reactor went dark after a five-foot section of uninsulated pipe seized up. Power outages quickly spread statewide – leaving millions shivering in their homes for days, with deadly consequences.
It could have been far worse: Before dawn on Monday, the state’s grid operator was “seconds and minutes” away from an uncontrolled blackout for its 26 million customers, its CEO has said. Such a collapse occurs when operators lose the ability to manage the crisis through rolling blackouts; in such cases, it can take weeks or months to fully restore power to customers.
Monday was one of the state’s coldest days in more than a century – but the unprecedented power crisis was hardly unpredictable after Texas had experienced a similar, though less severe, disruption during a 2011 cold snap. Still, Texas power producers failed to adequately winter-proof their systems. And the state’s grid operator underestimated its need for reserve power capacity before the crisis, then moved too slowly to tell utilities to institute rolling blackouts to protect against a grid meltdown, energy analysts, traders and economists said.
Early signs of trouble came long before the forced outages. Two days earlier, for example, the grid suddenly lost 539 megawatts (MW) of power, or enough electricity for nearly 108,000 homes, according to operational messages disclosed by the state’s primary grid operator, the Electric Reliability Council of Texas (ERCOT).
The crisis stemmed from a unique confluence of weaknesses in the state’s power system.
Texas is the only state in the continental United States with an independent and isolated grid. That allows the state to avoid federal regulation – but also severely limits its ability to draw emergency power from other grids. ERCOT also operates the only major U.S. grid that does not have a capacity market – a system that provides payments to operators to be on standby to supply power during severe weather events.
After more than 3 million ERCOT customers lost power in a February 2011 freeze, federal regulators recommended that ERCOT prepare for winter with the same urgency as it does the peak summer season. They also said that, while ERCOT’s reserve power capacity looked good on paper, it did not take into account that many generation units could get knocked offline by freezing weather.
“There were prior severe cold weather events in the Southwest in 1983, 1989, 2003, 2006, 2008, and 2010,” Federal Energy Regulatory Commission and North American Electric Reliability Corp staff summarized after investigating the state’s 2011 rolling blackouts. “Extensive generator failures overwhelmed ERCOT’s reserves, which eventually dropped below the level of safe operation.”
ERCOT spokeswoman Leslie Sopko did not comment in detail about the causes of the power crisis but said the grid’s leadership plans to re-evaluate the assumptions that go into its forecasts.
The freeze was easy to see coming, said Jay Apt, co-director of the Carnegie Mellon Electricity Industry Center.
“When I read that this was a black-swan event, I just have to wonder whether the folks who are saying that have been in this business long enough that they forgot everything, or just came into it,” Apt said. “People need to recognize that this sort of weather is pretty common.”
This week’s cold snap left 4.5 million ERCOT customers without power. More than 14.5 million Texans endured a related water-supply crisis as pipes froze and burst. About 65,000 customers remained without power as of Saturday afternoon, even as temperatures started to rise, according to website PowerOutage.US.
State health officials have linked more than two dozen deaths to the power crisis. Some died from hypothermia or possible carbon monoxide poisoning caused by portable generators running in basements and garages without enough ventilation. Officials say they suspect the death count will rise as more bodies are discovered.
THIN POWER RESERVE
In the central Texas city of Austin, the state capital, the minimum February temperature usually falls between 42 and 48 degrees Fahrenheit (5 to 9 degrees Celsius). This past week, temperatures fell as low as 6 degrees Fahrenheit (-14 degrees Celsius).
In November, ERCOT assured that the grid was prepared to handle such a dire scenario.
“We studied a range of potential risks under both normal and extreme conditions, and believe there is sufficient generation to adequately serve our customers,” said ERCOT’s manager of resource adequacy, Pete Warnken, in a report that month.
Warnken could not be reached for comment on Saturday.
Under normal winter conditions, ERCOT forecast it would have about 16,200 MW of power reserves. But under extreme conditions, it predicted a reserve cushion of only about 1,350 MW. That assumed only 23,500 MW of generation outages. During the peak of this week’s crisis, more than 30,000 MW was forced off the grid.
Other U.S. grid operators maintain a capacity market to supply extra power in extreme conditions – paying operators on an ongoing basis, whether they produce power or not. Capacity market auctions determine, three years in advance, the price that power generators receive in exchange for being on emergency standby.
Instead, ERCOT relies on a wholesale electricity market, where free market pricing provides incentives for generators to provide daily power and to make investments to ensure reliability in peak periods, according to economists. The system relied on the theory that power plants should make high profits when energy demand and prices soar – providing them ample money to make investments in, for example, winterization. The Texas legislature restructured the state’s electric market in 1999.
Since 2010, ERCOT’s reserve margin – the buffer between generation capacity versus forecasted demand – has dropped to about 10% from about 20%. This has put pressure on generators during demand spikes, making the grid less flexible, according to North American Electric Reliability Corporation (NERC), a nonprofit regulator.
That thin margin for error set off alarms early Monday morning among energy traders and analysts as they watched a sudden drop in the electrical frequency of the Texas grid. One analyst compared it to watching the pulse of a hospital patient drop to life-threatening levels.
Too much of a drop is catastrophic because it would trigger automatic relay switches to disconnect power sources from the grid, setting off uncontrolled blackouts statewide. Dan Jones, an energy analyst at Monterey LLC, watched from his home office in Delaware as the grid’s frequency dropped quickly toward the point that would trigger the automatic shutdowns.
“If you’re not in control, and you are letting the equipment do it, that’s just chaos,” Jones said.
By Sunday afternoon about 3:15 p.m. (CST), ERCOT’s control room signaled it had run out of options to boost electric generation to match the soaring demand. Operators issued a warning that there was “no market solution” for the projected shortage, according to control room messages published by ERCOT on its website.
Adam Sinn, president of Houston-based energy trading firm Aspire Commodities, said ERCOT waited far too long to start telling utilities to cut customers’ power to guard against a grid meltdown. The problems, he said, were readily apparent several days before Monday.
“ERCOT was letting the system get weaker and weaker and weaker,” Sinn said in an interview. “I was thinking: Holy shit, what is this grid operator doing? He has to cut load.”
Sinn said he started texting his friends on Sunday night, warning them to expect widespread outages.
‘SECONDS AND MINUTES’
Early Monday morning, one of the largest sources of electricity in the state – the unit 1 reactor at the South Texas Nuclear Generating Station – stopped producing power after the small section of pipe froze in temperatures that averaged 17 degrees Fahrenheit (9 degrees Celsius). The grid lost access to 1,350 MW of nuclear power – enough to power about 270,000 homes – after automatic sensors detected the frozen pipe and protectively shut down the reactor, said Victor Dricks, a spokesman for the U.S. Nuclear Regulatory Commission.
About 2:30 a.m. (CST), the South Plains Electric Cooperative in Lubbock said it received a phone call from ERCOT to cut power to its customers. Inside the ERCOT control room, staff members scrambled to call utilities and cooperatives statewide to tell them to do the same, according to operational messages disclosed by the grid operator.
Three days later, ERCOT Chief Executive Bill Magness acknowledged that the grid operator had only narrowly avoided the calamity of uncontrolled blackouts.
“If we hadn’t taken action,” he said on Thursday, “it was seconds and minutes (away), given the amount of generation that was coming off the system at the same time that the demand was still going up.”
(Reporting by Tim McLaughlin and Stephanie Kelly; additional reporting by Nichola Groom; editing by Simon Webb and Brian Thevenot)
UK could declare Brexit ‘water wars’ – The Telegraph
(Reuters) – Britain could restrict imports of European mineral water and several food products under retaliatory measures being considered by ministers over Brussels’ refusal to end its blockade on British shellfish, the Telegraph reported.
Senior government sources pointed to potential restrictions on the importing of mineral water and seed potatoes, the report said.
(Reporting by Maria Ponnezhath in Bengaluru; Editing by Daniel Wallis)
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