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In the beginning . . .
Assets have doubled every year since the first exchange-traded funds rolled onto the European scene in April 2000. Despite the challenges posed by multiple borders, cross-listings and multiple currencies, the market has expanded at a robust pace.
Exactly four years later, assets in Europe-based ETFs stand at $25.8 billion, which is invested in 109 products and growing.
Over the years, the number of ETFs available in Europe and the ability of Europe-based investors to support them have been a source of debate. Indeed, fears that European issuers had moved too far, too fast seemed to be vindicated following the closure of a number of sector- based ETF families in 2003.
However, many viewed these setbacks as hiccups, or simply the growing pains of an industry developing in the shadow of its older and more dominant sibling across the Atlantic .
Strong Asset Growth
While questions persist about the number and kind of products appropriate for the European market, few doubt that these products can expect a steady inflow of assets over the next four years and beyond.
"There are still many untapped market segments in Europe," says Bruce Lavine, who heads up Barclays Global Investors' ETF business in London ."There is much, much more penetration that can happen amongst high-net-worth investors, private wealth asset managers and pension funds, just to name a few."
Since moving from BGI's San Francisco office in November 2003, Lavine has had a chance to ponder the differences between the U.S. and European markets.
One of the important stories, he says, is that ETF assets held by European investors are significantly greater than they appear on paper.
On paper, European ETF assets include only those invested in Europe-based funds, and ignore those assets invested in U.S.-based ETFs by European clients.
"The reality is that European investors hold about $5 billion in U.S.-based iShares, which are not counted as European ETF assets," says Lavine. This is in addition to the approximately $6.1 billion invested in the BGI's Dublin-based iShares, which alone represent 23.6% of the European market.
While BGI can claim to have the largest base of ETF assets from European investors, Indexchange is the current leader in terms of ETF assets managed purely in Europe-based funds. Founded in October 2000 as a subsidiary of HypoVereinsbank AG, the firm currently has $6.9 billion in assets ¾ representing 26.9% of the market ¾ invested in more than 26 equity and five bond ETFs.
Rising To The Challenge
Indexchange first acquired the mantle of the largest asset manager in Europe-based ETFs in the autumn of 2001. It was subsequently overtaken by Merrill Lynch, but retook the lead in July 2002.
BGI then shot to the top following its purchase of the LDRS products from Merrill Lynch, which exited the European ETF market in September 2003. Indexchange, however, once again became the clear leader in the fall of 2003.
Among its achievements, Indexchange listed the first tradable European bond ETF in February 2003. The eb. rEXx Government Germany EX (RXRG) invests in the 25 most liquid German government bonds.
The firm plans to expand its presence in the bond ETF market, and is currently considering different categories of such products, including covered bonds, corporate bonds and pan-European government bonds, says chief investment officer Thomas Meyer Zu Drewer.
The bond category of products has also been the scene of much activity this year at Lyxor International Asset Management, a subsidiary of Société Générale.
Lyxor, which is Europe's third largest ETF issuer behind Indexchange and BGI, has already launched the EuroMTS Global Master Unit (MTX), the EuroMTS 3-5 year Master Unit (MTB) and the EuroMTS 10-to15-year Master Unit (MTE). Listed on Paris Euronext, all three of the ETFs will be cross-listed on Italy 's Borsa Italiana by June.
Lyxor manages $5.6 billion in ETF assets, which represents 21.7% of the market, across 11 ETFs.
Sector Mishaps
No area of the market has come in for more change than sector products, which has seen both Merrill Lynch and BGI discontinue their offerings. Much initially was staked on sector ETFs by sponsors betting on a unified Europe linked by a common currency. But the prolongation of a fragmented market meant sector ETFs were difficult to price and trade because they cross borders.
In addition, sector ETFs' lack of liquidity and daily volumes gave the impression that their spreads were too large, leaving issuers with an uphill battle to win over asset managers who have traditionally preferred executing certificates of swaps rather than buying ETFs-and still do.
The issuers of sector ETFs have also struggled under a Europewide ruling that no investment in a single share can be higher than 5%, or alternatively no higher than 10% as long as it makes up no more than 40% of a whole fund.
Indexchange, which is one of the few remaining issuers of European sector-based ETFs, attributes much of its success to an exemption to this rule for German funds that fully replicate an underlying index, says Meyer Zu Drewer. "The index replication is quite high in our products, which I think made the quality of our sector ETFs better than those sector ETFs that have closed," he says.
Sector-based exchange-traded funds will continue to be important going forward, thanks to an increase in the appetite of institutions for sector rotation strategies, says Debbie Fuhr, a London-based global ETF strategist for Morgan Stanley.
"I think we will start to see traditional mutual funds being launched that will use ETFs to implement sector rotation and tactical asset allocation," says Fuhr.
She believes that the next era in the European ETF market will see significant growth in the number of institutions using the products and the creation of products covering as-yet-untouched asset classes. New product categories will include the first leveraged ETF, which will be launched by Sweden-based XACT later this year.
Looking Ahead
When it comes to industry consolidation, Fuhr believes that for the most part, this has already occurred, notwithstanding the possibility that a merger in the asset management industry generally may result in further consolidation.
Although the ETF industry still may be in its infancy, there is no doubt that the European market has developed as the domain of the big boys. It is no accident that the largest issuers have the backing of parent companies with powerful market-making capabilities, says Isabelle Bourcier, the global coordinator of ETFs at Lyxor.
"The advantage is that liquidity can be provided in a consistent manner, which is crucial for a product like ETFs where the secondary market is so important," says Bourcier.
Still more opportunities will emerge for issuers to cross-list their products on multiple new exchanges, such as the Iceland Stock Exchange, which announced its intention to begin listing ETFs later in the year.
Lyxor, which already lists its ETFs in France, Italy and some in Germany , is currently working on listings in Switzerland .
"Ultimately we are developing a global and local product approach at the same time," says BGI's Lavine. "We are very aware of the local needs and preferences, and we are trying to accommodate those where we can; but we also want to have a global offering."
Despite closing its sector ETFs, BGI plans to reinvest in products for which it believes the market has a bigger appetite, says Lavine. These include the iShares FTSE 250 (MIDD) and the iBoxx Corporate Bond fund (SLXX) already launched this year.
"We have much planned for later in the year, so stay tuned," he says. |
2004
