Corporate Debt and Inflation-Linked Bonds Are Amongst this Year’s Best Options in Fixed Income

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Deuda corporativa y bonos ligados a la inflación: entre las mejores opciones en renta fija para este año
Pixabay CC0 Public DomainPhoto: Petraboekhoff. Corporate Debt and Inflation-Linked Bonds Are Amongst this Year’s Best Options in Fixed Income

Asset management companies agree that 2018 will be characterized by a low rate environment and by a slow normalization of monetary policies calculated step by step to avoid damaging global growth. Once again, this leaves us with the same question as to what to expect from fixed income, to which so many investors and asset managers look with suspicion due to the low profitability it offers.

Where will the opportunities lie in this type of assets? For Hans Bevers and Bruno Colmant, Chief Economist and Head of Macro Analysis respectively, at Degroof Petercam, the context has to be taken into account. Neither one expects the normalization process of monetary policies to produce much higher yields than long-term bonds.

In an environment of very low interest rates, Degroof Petercam proposes the following alternatives to sovereign debt: investment grade corporate debt in Euros, which offers a limited return, but with durations that are often shorter than those of sovereign debt, and international bonds linked to inflation.

“Although inflation levels have recently disappointed, inflation-linked bonds remain attractive considering that overall growth forecasts and the improvement of the labor market situation should translate into a modest rise in inflation. We believe that valuations of inflation-linked bonds do not fully reflect this perspective,” says Jérôme van der Bruggen, Head of Private Banking Investment at Degroof Petercam.

In turn, SYZ AM points to credit as a key asset for 2018 within fixed income, despite its high valuations and the risks involved. “As far as the bond market is concerned, everyone knows that the sovereign returns of Western countries are low. However, it isn’t the government bond segment where the values of the fixed-income market are trivial. It’s in corporate credit. After years of ultra-accommodative monetary policy and a desperate search for profitability by investors, corporate credit in general, and high-yield markets in particular, have become the most expensive asset class in the world,” says Hartwig. Kos, Vice-CIO of Investments and Co-Head of Multi-assets at SYZ AM. He advises that, in an environment where inflationary pressures are rising and the stance on the ECB’s monetary policy is tightening, the high-yield market and its valuations are “clearly vulnerable.” According to Kos, “in investors’ minds at the present moment the asset class chosen is equity. And, in fact, although bonds are expensive, in comparison, equity is at a reasonable value. This is obviously a relative argument, but when you look at equity valuations in absolute terms the picture looks quite different.”

USA

AtEthenea, they take this into consideration and do not expect a rate hike, but they do not rule out that there will continue to be a significant demand on fixed income. “In this environment, and with continued demand from both domestic and foreign institutional investors, we believe that the pressure on long-term bonds should remain moderate. At the same time, continued strong economic conditions, favorable refinancing conditions, and low default rates should support spreads on corporate bonds,” explains Guido Bathels, Portfolio Manager at Ethnea Independent Investors.

According to Bathels, in the United States, we find a slightly different environment given the time of the economic cycle in which it is and the short-term increase in interest rates. “It’s possible that the rate increase of the first half of the year is corrected downward during the second half due to economic concerns. If this reverses, the profitability curve during the year would be a clear indicator of an impending economic slowdown. This prospect could put pressure on the risk premiums of corporate bonds. This type of scenario would definitely have an impact on interest rates and spreads in Europe towards the end of the year,” he explains.

In this context of global growth, but certain financial uncertainties, Bathels argues that active management and a flexible investment approach will be very important in order to not miss the opportunities that arise in the fixed income market.

Gonzalo Milans Del Bosch Takes Over As Santander Asset Management’s New CIO

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Santander Asset Management nombra a Gonzalo Milans Del Bosch nuevo CIO
Pixabay CC0 Public DomainGonzalo Milans Del Bosch, courtesy photo. Gonzalo Milans Del Bosch Takes Over As Santander Asset Management's New CIO

Santander Asset Management, has a new CIO. Gonzalo Milans Del Bosch has been chosen to replace the current head of Investments, Dolores Ybarra, according to sources close to the bank that confirmed the news to Funds Society.

Ybarra, which was CIO since 2011, will now be the Global Head of Products and will support Milans Del Bosch in the transition to adopt its new functions.

Milans Del Bosch has until now been responsible for the  Investment “Inversiones y Participaciones” division of Banco Santander.

Lyxor Sees in ETFs an Opportunity for Sustainable Investment to Continue Growing

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Lyxor ve en los ETFs una oportunidad para que la inversión sostenible siga creciendo
CC-BY-SA-2.0, FlickrFrancois Millet, courtesy photo. Lyxor Sees in ETFs an Opportunity for Sustainable Investment to Continue Growing

Lyxor ETF has a new route for sustainable investment. The firm argues for the expansion of this type of investment and how ETFs have become a remarkable vehicle to invest under ESG criteria. A trend that the firm believes will continue to grow given that so far only 1% of European ETFs follow these investment criteria.

According to the management company’s assessment, these figures show great potential for growth. In addition, in terms of investment strategies, and taking Europe as a reference, it is observed that all strategies increased since 2013. As an indication, Lyxor ETF points out that just those strategies with exclusion criteria grew by 22% in 2015, as compared to 2013. This trend is compounded by the popularity and demand for passive strategies, which leaves the ideal framework for the development of sustainable investment through ETFs.

“ETFs can democratize access to these strategies because it is difficult for an investor to participate in certain assets, such as green bonds, for example. Instead, by using ETFs to diversify the portfolio, this type of asset can be accessed. In addition, it should be noted that they have lower costs, especially those that are contracted through digital platforms,” explains Francois Millet, Head of Product Line Management at Lyxor. Due to these qualities, Millet argues that it will be the millennial investors who will resort more readily to this type of solutions.

In his analysis of sustainable investment, Millet points out that, within the status that sustainable investment has in Europe, “we observe that the strategies that grow the most, investment through exclusion, impact investment, and sustainability issues, are precisely those invested in by passive management,” he says.

At Lyxor ETF, they have addressed this type of investment with two proposals: thematic investment and investment in indices. “In the case of the thematic investment, we have four ETFs that are within the theme of the UN Millennium Goals. They are related to energy, equality, water and green funds. Transforming these objectives into investment strategies is complicated, but it can be done by participating in the market of those megatrends which affect these issues,” says Millet.

Regarding their second proposal, the indices, he emphasizes that “investment is based on the sustainable rating of the companies. However, in order to consider these indices, data, exclusion strategies by sector or activity, and demonstrating that they prioritize certain objectives, are required”. In this regard, the firm uses the MSCI indexes.

Passive vs. active

At Lyxor ETF, they opt for an active use of passive management or, at least, a smart combination in order to address market needs. “In less efficient market areas, active managers are able to capture greater profitability; while in more efficient markets it is more complicated, and therefore, passive management makes more sense because the active manager has a harder time achieving good investment behavior”, explains Marlène Hassine Konqui, Head of ETF Research at Lyxor, who argues that the conflicting vision of active management versus passive management is wrong.

“For us, it makes more sense for active managers to include passive strategies in their portfolios which allow them to capture returns or help the portfolio to have a certain behavior,” she points out. According to her estimates, the perfect balance between these two management styles would be 70% of passive management and smart beta strategies, and 30% of active management.

What Were the Asset Management Industry’s Major Business Operations in 2017?

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¿Cuáles fueron las grandes operaciones de negocio de la industria de gestión de activos en 2017?
Pixabay CC0 Public DomainDevanath. What Were the Asset Management Industry’s Major Business Operations in 2017?

2017 was a good year for operations, acquisitions, mergers and expansion into new markets by leading international asset management companies; yet another example of the asset management industry trend towards higher concentration, while seeking higher efficiency and margin growth. Technology, regulatory changes, opening into new markets and strengthening their product supply capacity put these operations into context.

One of the major ones was the Aberdeen Asset Management and Standard Life merger, which together have become one of the largest investment companies in the world with 737 billion Euros in assets under management. The merger was closed in August, after the operation was announced in early March.

According to the firm, the merger leverages the complementary capabilities of both companies, leaders in the investment and savings market. The result is an investment group with strong brands, at the forefront of institutional and wholesale distribution franchises, market leading platforms and access to lasting strategic alliances globally.

Also, by combining the strong balance sheets of both companies, the resulting group has greater capacity for investing, as well as to grow and innovate. Together, Standard Life Aberdeen has offices in 50 cities around the world, serving clients in 80 countries. In addition, the firm maintains a market capitalization of more than 12.1 billion Euros (11 billion pounds).

The other two major operations in 2017 were the merger between Henderson and Janus Capital, and Amundi’s acquisition of Pioneer Investments. Regarding the first of those operations, it was carried out through a share exchange: each Janus share was exchanged for 4.719 new Henderson shares. With this exchange, Henderson shareholders took control of 57% of the capital and Janus shareholders of the remaining 43%. The resulting company, Janus Henderson Global Investors, has 320 billion dollars in assets under management and a market capitalization of around 6 billion.

The combination of both businesses has created an important global leader in asset management with a significant scale, as well as a great diversity of products and investment strategies, and great depth in global distribution of funds. In fact, Janus’ strength in the US market will combine with Henderson’s in the United Kingdom and Europe, creating a very global management company, with a very diverse and widespread geographic footprint.

The acquisition of Pioneer Investments, which was closed towards the end of 2016 for an amount of 3.545 billion Euros, is the third major operation that the sector saw last year. During the first six months, Amundi established the new group’s growth strategy, defined the priorities of its business lines, and established an integration plan; so that by July it was able to completely close the purchase.

Although with a little less dimension than the previous operations, another important transaction within the industry has been Schroder’s acquisition of Adveq, an asset manager specialized in private capital worldwide. As a result, of Adveq’s acquisition – which was renamed Schroder Adveq – Schroders’ private assets business rose to more than $ 7 billion in client commitments.

Other Operations

Other operations carried out by asset management companies with the aim of growing in markets where they already had a presence have perhaps been less striking. The clearest example was BlackRock’s purchase of Citi’s asset management business in Mexico in November 2017. With this operation, BlackRock in Mexico doubled its size.

In fact, BlackRock and Citibanamex, a member of Citigroup, signed an agreement for BlackRock to acquire Citibanamex’s asset management business. Impulsora de Fondos Banamex, has approximately 31 billion dollars in assets under management through fixed-income products, equities, and multiple asset products, mainly for consumer banking clients.

UBS also looked at growth possibilities in Latin America and bought CONSENSO, Brazil’s largest family office, in May. Both companies closed an agreement under which UBS acquired a majority stake in the Brazilian multi-family office that will result in the combination of its wealth management operations in Brazil. The resulting division is being directed by both, UBS executives and CONSENSUS’ founding partners.

With this operation, UBS consolidated its capabilities in Brazil, improving its offer for local clients and offering advice from a global player in the sector. The entity recognized after closing the agreement that this transaction allows them to accelerate their expansion in Brazil and to reaffirm their commitment to grow the wealth management business.

And for 2018?

These are just some of the most significant operations of 2017, which was a year when the industry showed some concentration and the search for synergies. The trend has continued during the first weeks of 2018, during which we have already witnessed First Eagle Investment Management’s acquisition of NewStar Financial, and the announcement of a merger agreement between Quaero Capital and Tiburon Partners. The big question now is what else will this year bring.

According to experts, it would not be unusual for this trend to continue as asset management firms face a change in their own industry marked by technological challenges, such as blockchain technology or bitcoin development, by new millennial consumers, by passive management’s strength, and by the pressure that all this is asserting on its margins.

Franklin Templeton Investments to Acquire Edinburgh Partners

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Franklin Templeton Investments llega a un acuerdo para adquirir Edinburgh Partners
Pixabay CC0 Public DomainPhoto: Mikewiz. Franklin Templeton Investments to Acquire Edinburgh Partners

The M&A market is off to a good start of the year with Franklin Templeton Investments announcing that it has entered into an agreement to acquire Edinburgh Partners Limited, which managed approximately US $10 billion as of December 31, 2017 in global and emerging markets equities. The transaction is subject to regulatory approvals and is expected to be completed in the first half of 2018. Terms of the transaction were not disclosed.

Jenny Johnson, president and chief operating officer of Franklin Resources said, “We’re pleased to announce the acquisition of Edinburgh Partners, an established global value investment manager, and to welcome back Dr. Sandy Nairn to our organization. Dr. Nairn worked alongside the late legendary global investor, Sir John Templeton, and was employed by Franklin Templeton for more than a decade. He brings a tremendous amount of leadership experience and expertise in managing global and international equities, an area that continues to be of strong interest to our clients around the world. This is the latest example of the firm continuing to make strategic investments in relatively small, yet highly experienced asset management teams that complement Franklin Templeton’s global offerings.”  

Nairn will become chairman of Templeton Global Equity Group and remain investment partner and CEO of Edinburgh Partners. He will report to Stephen Dover, Franklin Templeton’s head of Equities.

Based in Edinburgh, with an office in London and two in the United States, Edinburgh Partners is an independent fund management company that invests globally with an emphasis on absolute returns over a long-term time horizon. Its team of 12 investment professionals are highly regarded within the international asset management industry, with a combined average tenure of 22 years managing four distinctive strategies. 

Templeton Global Equity Group is a pioneer in global investing, with a storied investment philosophy that dates back to the 1940s. Templeton’s team of 39 experienced investment professionals, based in offices around the world, search for undervalued stocks across all sectors and regions globally. Templeton Global Equity Group manages over US $101 billion in assets as of December 31, 2017.

“Dr. Nairn and his experienced team will be an excellent addition to our global equity capabilities,” said Dover. “As chairman of Templeton Global Equity Group, Dr. Nairn will bring many new insights to share, having run his own firm for the last 15 years, while also drawing upon his in-depth knowledge of the Templeton investment philosophy and process from his many prior years with the group. We look forward to having Dr. Nairn and his team join our strong lineup of investment groups.”

Nairn said, “I am very excited to be coming back to Templeton, the company that gave me my great appreciation for global investing. My team and I are deeply familiar with the history and strong reputation of the broader Franklin Templeton organization, and we’re pleased to join such a well-regarded firm. I look forward to sharing my perspective and experience with the Franklin Templeton organization. The access to Franklin Templeton’s extensive global resources will allow me to focus my time on investment management, as we continually seek to bolster our investment process and enhance our clients’ experience.”  

 

What Would 2018 Look Like for Private Equity Investors?

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What Would 2018 Look Like for Private Equity Investors?
Photo: wolfgang11. What Would 2018 Look Like for Private Equity Investors?

2018 is expected to have an increase in global growth and, according to William Charlton, Managing Director at Pavilion Alternatives Group, most institutional investors are maintaining or increasing their allocations to private equity.

While growing economies generally would be beneficial to most private equity fund managers, with the possible exception of distressed managers, Charlton believes that 2018 is shaping up to be a year of challenges as well as opportunities. “The capital deployment issue is one of the known knowns, but as Donald Rumsfeld has argued, the bigger risk may well be from the unknown unknowns.” He states.

In his opinion, the biggest challenge facing the U.S. venture capital market is the IPO environment.  “While the IPO market showed some signs of recovery in early 2017, several IPOs were not well received and it remains very difficult to successfully navigate the intricacies of taking a company public.” On a more positive note, he expects the repatriation of large amounts of capital currently held by public companies in off-shore accounts due to the tax reform, a situation he considers could impact positively on an already robust acquisition market.

Meanwhile, in Europe, fundraising activity has increased recently while both deal flow and exits have been declining in the European buyout market, and EBITDA multiples “are up significantly over recent years and are approaching the lofty levels already seen in the United States. If prices remain high and expected economic growth remains bounded, European fund managers will be challenged in 2018 to generate historically attractive private equity returns commensurate with their risk profiles.  Furthermore, the uncertainty induced by Brexit adds to the complexity of accurately assessing risk-return exposures across the region.”

In contrast to the mixed measures for both the U.S. and European markets, deal flow, exits, and fundraising are up in Asia-Pacific private equity markets. Given the region’s export-dependent nature, Charlton believes investors focused on it will face the continued challenge of investing in companies that can be successful even in the event of a decrease in global demand.

Regarding oil and considering its prices have enjoyed a steady recovery puting them at a level Charlton believes are attractive investment opportunities, he believes a challenge “is identifying quality private equity fund managers that can consistently generate attractive returns when the underlying value of their assets are highly dependent on a decidedly volatile commodity.” In infrastructure, he believes the biggest challenge will be identifying assets that have the potential to generate attractive returns despite the higher entry prices.

Private credit markets have seen rapid growth in recent years as many institutional investors seek a broader opportunity set to increase returns in their fixed income portfolios.  Consequently, private credit is enjoying a strong fundraising market.  However, it appears that some fundamentals in private credit markets may be weakening. The increased interest in private credit has led to a decrease in spreads as well as an increase in covenant-lite deals. “If the recent economic recovery does not sustain, we could be seeing the initial phases of a perfect storm in global credit markets.  If so, distressed fund managers may be well-positioned to take advantage of current overly lenient terms. The challenge in credit markets for 2018 will be finding fund managers that are able to issue loans with terms that provide some protection in the event of an economic decline.” He concludes.
 

Institutional Investor Journals to Join Pageant Media

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Pageant Media anuncia la compra de Institucional Investor Journals
Pixabay CC0 Public DomainJackmac34. Institutional Investor Journals to Join Pageant Media

Pageant Media, the business information specialist, acquired the Institutional Investor Journals (II Journals), a business which produces in-depth, original and practical research in global investment and finance aimed at professional institutional investors. The portfolio consists of 12 titles, covering various disciplines in portfolio management and has an extensive online archive of almost 10,000 research articles. The Journal of Portfolio Management is the flagship title, recognised as the authoritative practitioner research title.

Pageant Media is one of the financial sector’s fastest growing providers of intelligence and insight. The company, founded in 1998, provides membership services offering senior professionals – across a range of industries, including hedge funds, mutual funds, private equity and real estate – exposure to market leading news and analysis, data and events.

This acquisition provides Pageant Media with synergy opportunities within its existing market-leading products, notably Fundmap, HFM Global and Fund Intelligence, and will increase the company’s reach in the institutional investment space.

Commenting on the announcement, Charlie Kerr, Chief Executive of Pageant Media, said: “The II Journals are recognised across the asset management sector for their excellence in providing senior professional investors and leading academics with informed and thought-provoking technical analysis. We look forward to investing further in these titles and are excited to begin thinking about the ways in which the specialist knowledge exhibited in these journals can bolster the growing information and networking services we provide to our hedge fund, private equity, real estate and mutual fund communities.”

Institutional Investor Journals were previously owned by Euromoney Institutional Investor, with the business located in New York. Staff will join Pageant Media’s New York offices.

Cooperation Between Fundinfo and UBS Fondcenter for Fund Data Management

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UBS Fondcenter y fundinfo se alían en la gestión de datos de fondos
Photo: Pxhere CC0. Cooperation Between Fundinfo and UBS Fondcenter for Fund Data Management

UBS and its group company Fondcenter have commissioned fundinfo to procure and source fund data from fund providers and asset managers. In order to provide efficient, legally compliant investment advice, UBS Fondcenter’s external and internal partners require on-demand access to complete, accurate and up-to-date fund information, including MiFID II and PRIIPs data. They also rely on the openfunds standard for fund data that was launched and is being continuously enhanced by UBS Fondcenter, Credit Suisse and Julius Bär. 

“Fundinfo has many years of experience in the procurement, validation and distribution of fund information and meets our high quality requirements”, says Christophe Hefti, head UBS Fondcenter at UBS Asset Management. “By partnering with fundinfo, we can concentrate on our core competencies and expand our range of services, including data preparation. At the same time, we are providing fund providers with an experienced partner for high-quality fund data and document management.”

“After working successfully with UBS Fondcenter for many years in the area of fund document management, we are pleased and proud that UBS Fondcenter has now placed their trust in fundinfo to perform their fund data management” says Jan Giller, Head of Sales & Marketing at fundinfo. “It is a privilege and a strong testament to our capabilities that the largest asset manager in Switzerland has chosen to work with fundinfo to procure their fund data”.

 

It’s That Time of Year…For Tax Loss Harvesting

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Es esa época del año… para la cosecha de pérdidas patrimoniales
Foto cedida. It’s That Time of Year…For Tax Loss Harvesting

December has historically been a very favorable month for the US equity markets. Whether this is due to the big institutional money managers being strongly incentivized to help the market end the year on a positive note, or just from the psychological boost that comes from the holidays, we may never truly know. What we do know is that the last couple of weeks of the year can bring some additional selling pressure on stocks that have had sharp declines during the year. Very simply, this is caused by tax-loss selling, a process where investors that are subject to U.S. tax laws will “harvest” (i.e. sell) positions that have a loss in order to reap a tax benefit. For those holding positions prone to tax loss selling, it can be like rubbing salt in your wounds as your positions that have not fared well this year get dumped right around Christmas time.

This year we may experience an exaggerated version of this effect for several reasons. The main one is that investors are expecting tax reform to be signed, sealed and delivered for 2018. All else being equal, investors would rather sell a losing position now in December where it gives them the most benefit rather than selling a few months later for a lesser reward. The most obvious impact from tax reform is the reduction of the rate for the highest tax bracket. This incentivizes investors to harvest their losses in 2017 while the highest marginal tax rate is still 39.6%. Short term capital gains (those of less than 1 year) in the US are taxed at your personal rate and not the 20% used for long tern gains. The Senate version of tax reform will give the wealthy a bit of a bonus by shaving that maximum personal rate to 38.5%.

Furthermore, one of the features of the proposed tax reform is the elimination of an investor’s ability to select which lot to sell. Currently, if an investor has purchased a stock at several different points in time (creating multiple “lots”), and he wants to then sell a portion of his position he can select which lot is most advantageous from a tax perspective. This usually means selling the lot with the largest loss. The proposed tax reform includes a provision that would disallow that practice and force investors to sell the oldest lot first in a FIFO manner (First In First Out) regardless of the gain or loss which amounts to a backdoor capital gains tax increase. Although we do not yet know if this will make it to the final version of tax reform, investors are very likely to be taking action and selling affected positions before 2018.

With the S&P 500 up 18% this year, most investors are sitting on some hefty gains and to the extent that profits are being taken, the pressure to offset the tax impact increases. However, the selling may not be limited to this year’s losers either. The tech sector has had a massive gain this year and could cause some institutional funds to do a bit of portfolio rebalancing before yearend. This may even lead to a bit of a vicious cycle as investors trying to align their portfolios to benefit from tax reform (specifically the lowering of the corporate tax rate), which would entail selling off stocks within sectors that have low tax rates such as technology and rotating to sectors that typically pay high tax rates (financials, consumer and telecom). The more technology stocks with large gains that are sold, the more demand there will be to harvest some of those losers.

Many of the big losers that can see additional selling are clustered within the consumer discretionary and the energy sectors. Within consumer discretionary, the traditional brick and mortar department stores have been one of the worst groups in the market as their businesses struggle against the move towards ecommerce. Even with the recent rally these stocks have had in November, many of them remain far below their 2016 levels. For example, JC Penney is down 61%, Sears Holding is down 54% and Signet Jewelers is down 43%. Even bellwether retailer, Macy’s, is down 27% this year. Outside of direct brick and mortar retail, athletic apparel distributor Under Armour is down 53%. In the energy sector, quite a few service companies were bid up after President Trump’s election in the last 2 months of 2016. However, 2017 has been a different story as US Silica is down 41% and Hi-Crush Partners has been well crushed for 46%. Retail and energy are not only groups where potential tax loss selling candidates can be found, as generic drug maker Teva Pharmaceuticals is down 55%.

Column by Charles Castillo, senior portfolio manager at Beta Capital Wealth Management. Crèdit Andorrà Financial Group Research.

As Rules Regarding the Creation of Synthetic ETFs Become More Stringent, They Could Have an Impact on Growth

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"La regulación más estricta sobre ETFs sintéticos podría impactar en el crecimiento y la velocidad de convergencia entre el mercado de ETFs en Europa y EE.UU."
Agnieszka Gehringer and Kai Lehmann, courtesy photos. As Rules Regarding the Creation of Synthetic ETFs Become More Stringent, They Could Have an Impact on Growth

According to Agnieszka Gehringer and Kai Lehmann, members of the Research Institute of Flossbach von Storch, ETFs go beyond passive investment, due to their hyper trading activity and the latest innovations in the field of smart beta. In this interview with Funds Society, the experts also warn of the uncertain behavior of ETFs in turbulent periods, something not yet tested, and are confident of the industry’s potential for growth in Europe, although, they are aware the stricter rules on the creation of synthetic products could be a drag on its development.

 What do you intend when you doubt that ETFs are passive?

The ETF are often put in the context of passive investment, based on the fact that they follow the performance of a certain index. This is exactly the idea staying behind the traditional index funds – an invention of Jack Bogle dating back to 1976. But Bogle aimed at providing an instrument for a long-term investment in stock market by simply following the index. To the contrary, ETF investors are very much short-term focused. They trade ETF shares very actively, indeed hyper-actively. This is what we find in our analysis based on the three biggest equity ETFs tracking respectively the German DAX, the US S&P 500 and the FTSE 100 in the UK. The volume of the ETF shares traded on average every day is four times higher than the traded stocks of the underlying indices. This hyper-activity brings the idea of passive investment ad absurdum.

Has the innovation propagated the creation of ETFs which can be called active? Isn’t it a contradiction? How does the passive and active investing complement one another in an ETF?

Besides the traditional ETF there is indeed a growing interest in the so called smart beta ETFs. Whereas the traditional ETF are supposed to reconstruct 1:1 the index performance based on the market caps of the index constituents, smart beta ETFs weight the basket of the underlying securities based on alternative criteria, called factors. In this way, they aim at performing better than the market and thus better than traditional ETFs. These factors may relate to some kind of assessment of accounting metrics of the index constituents, like book value, dividends, or cash flows, or to still other factors, such as low volatility, undervaluation or expected momentum. In this sense, smart beta ETFs add an active layer with respect to traditional ones: they are not only actively traded, but render the underlying investment choice active as well. Is it a contradiction? I wouldn’t say so – it is more an enhancement on the activity scale. But the important thing to note is that such “active” choices are not comparable with the investment decision made by an active asset manager who thoroughly analyse the entire business model of a company in order to assess its intrinsic value. Smart beta strategies are focused on fast-track, partial, rather than thorough, and more quantitative, rather than qualitative assessment of companies.

Due to this innovation, could ETFs push the active strategies aside?

Given the current popularity of ETFs, be it traditional or smart, it wouldn’t be surprising to see further rise in the relative share of ETF-managed funds. At the same time I would doubt whether it is in the interest of ETF investors to fully eliminate active investment strategy. In the end ETFs freeride on the contribution which active managers deliver to the efficient price building on capital markets. By the same token, we can’t exclude that upon the attainment of a certain critical mass on capital markets by ETFs, the price building process might get into difficulties.

It is often stated that both types of investment strategies would survive. What would be the role played by the one and the other?

It is plausible to expect that both ETFs and active management will coexist. On the side of ETFs, they have been surely attractive so far, given the positive past performance on capital markets and their warranty of obtaining the performance of the underlying index. They could be thus appropriate for investors willing to simply follow the market. At the same time, not much is known so far about ETFs’ performance under difficult weathering conditions on capital markets. Only when markets enter more turbulent waters will we be able to assess the true performance of ETFs. For now ETF investors should keep this uncertainty in mind. On the side of active managers, and especially of those following a consistent and well-founded investment strategy, they will continue to play a role in enhancing the price setting on markets, especially when we see some market turmoil.    

In your opinion, which was the major innovation in the world of ETFs during the last years?

The original idea of following the market in order to enjoy the long-term positive return at a rock-bottom cost is quite revolutionary. Their invention may have helped to get in touch with capital markets. But today there is not much left out of this. To the contrary, the hyper-activity of ETF trading and allegedly “smart” investment choices of smart beta ETFs could pose more risks than benefits, should capital markets experience turmoil in the future.

In launching of novelties (smart beta, currency hedging (?), …), where could the next innovations go in the world of ETF?

Given the past creativity in the field of ETFs, the innovation could go anywhere. Just think of the different kinds of thematic or even esoteric ETFs, like for instance “biblically responsible” ETFs… If this trend continues, the question will be increasingly about the risk-reward balance of less diversification and less market liquidity versus chances to pick up an index performing better than the others. All in all, there seem to be less and less well-founded investment choices.

Is the use of ETFs changing – from tactic to strategic positioning? Does this generalization in the use regard all types of investors?

This seems to be particularly the case for institutional investors. In the past, they were using ETF for cash equalization and transition management. But now the growing use for core exposure can be observed.

Comparing the markets, the European with the US market, Europe is lagging behind, but could still catch up. How much could the European industry grow?

The size of the ETF market in Europe is indeed significantly smaller than in the US. Precisely, the total assets held by US-ETFs now add up to about 3.3 bn. USD whereas its European counterparts are currently approaching the roof of 1 bn. USD. There is surely catching up potential for Europe. At the same time, there are some important regulatory changes applying next year, which could decelerate the process. Precisely, rules regarding the creation of the so called synthetic ETFs become more stringent. Accordingly, given the current non-negligible share of synthetic ETFs in Europe, this could have an impact on growth and the speed of convergence between the European and US ETF market.

Could the regulation have an impact on the use of ETFs and why?

As mentioned above, the regulation is already having an impact on the use of – in this specific case synthetic – ETFs. But more generally, given that ETFs can still be considered as relatively new to the financial market reality, the regulators have to gather information and experience regarding the functioning of ETFs. This task is not easy and regulators could lack the necessary information to set up well-functioning rules. And the past teaches us that unfortunately sometimes it needs an external shock to discover the loopholes in the system. Hopefully this time is different.