The EDHEC European ETF Survey 2008, sponsored by iShares, was released in June, and gives a useful feel for the state of play in the institutional investor market, and the general level of European interest in ETFs.

Based upon a questionnaire completed by 111 institutional investors from across the region, the results can also be compared with the 2006 survey to give a feel for how things have changed.

What's notable in the report?

First, the overall use of ETFs in Europe has risen across all the major asset class categories in the two-year period since the last survey. More than three-quarters of the respondents are using equity ETFs, and nearly half now use ETFs to track government bonds, corporates and commodities.

User satisfaction levels have also risen for all ETF categories—staying at above 90 percent for equity ETFs, and getting near that for government bond and commodity ETFs.

Satisfaction levels in the other categories, though rising, remain lower.

So ETF usage is now pretty broad and investors have a generally favourable impression. There's nothing surprising here. But what does catch the eye is a table showing how ETF use is not confined solely to the core institutional portfolio.

One of the key arguments of the active fund management industry has been that, while it may make sense to use indexing strategies in the core portfolio, the "satellite" part should be left to the "alpha"-producing fund managers; those in theory able to provide returns in different market conditions, such as hedge fund managers.

What the EDHEC survey suggests is that ETFs are used as readily in the satellite portion as in the core, meaning managers are just as happy to use passive trackers (and then presumably take asset allocation bets) as to stock-pick.

Whichever way you look at it, the indexers are encroaching. And why not? After all, the cost of active management has gone up in the last decade, even though the returns to investors (in developed market equities, at least) have been disappointing.

Another interesting table shows the extent to which ETFs have penetrated the overall market by illustrating the percentage allocated to ETFs within each asset class.

The standout figures are in equities, where ETFs now represent over 20 percent of all invested assets; and commodities, where ETFs and ETCs have been a big success story in harnessing investor assets during the boom so far this decade.

By contrast, assets allocated to bonds via ETFs are lower in percentage terms, despite the fact that the share of the overall European ETF market devoted to fixed income is higher than in the U.S. If the recent arrival of the heavyweight investment firm, PIMCO, in the U.S. fixed-income ETF sector is anything to go by, bonds may well be an area of the market attracting new managers and new product development activity. The other two asset classes showing relatively low ETF penetration—real estate and hedge fund-type products—should also attract some product innovators.

The EDHEC survey also includes a number of tables showing how the surveyed managers rate ETFs against other index-tracking instruments—futures, total return swaps and traditional index funds—with rankings assessed across a number of categories: cost, liquidity, coverage, tracking error, transparency, minimum subscription levels, operational constraints and the regulatory regime.

This is the most comprehensive review of its type that I've seen and has been well thought out.

The overall conclusion from this section is that futures are the most direct challenger to ETFs, with futures outscoring ETFs in the categories of liquidity, transparency and cost, but ETFs ranking higher in terms of the range of available markets and asset classes, and with regards to minimum subscription levels, operational constraints, and the tax and regulatory regime.

Here it's worth remembering that the survey was conducted amongst institutional investors, many of whom will have no problems dealing with margin calls, collateral management and other operational issue relating to futures. If retail investors were to be involved, the advantages of ETFs would stand out even more clearly.

When the EDHEC survey then asked respondents to summarise how their anticipated use of these four categories of trackers could be expected to change, the following picture emerged.

Over two-thirds of respondents expected their ETF usage to increase, a higher proportion of managers than for any of the other instruments—even though more managers were likely to increase than decrease allocations in all four categories. This testifies both to the likely further increase of indexation amongst European investors—at the expense of active managers—and to the likely lion's share of the increase being allocated to ETFs.

In terms of the way in which increased allocations to ETFs are likely to be made, the two main areas of note from the survey were using ETFs to gain exposure to new asset classes, and constructing optimal portfolios of ETFs (see the pie chart below).

Using ETFs to extend asset class coverage is an unsurprising answer from the survey participants, but it's interesting to see that over a quarter of the respondents aim to construct optimal portfolios of ETFs. We've seen a growth trend of ETF-only fund managers in the U.S., often using ETFs to gain both long and short exposure in a portfolio and run in a similar way to the original global macro hedge funds, and it would seem there is fertile ground for similar strategies to develop in Europe.

And in terms of new asset class coverage, the survey indicates the most sought-after sectors are in emerging market debt and equities, alternative asset classes and commodities. There's not much obvious demand for active ETFs, despite the hype about these.

In summary, and based on the findings of the EDHEC survey, the European ETF market is extending its scope and investor base; there is still a substantial shift to indexing going on, from which ETFs should be the prime beneficiaries; and there are still plenty of areas of the market that ETFs can reach into to provide asset class coverage.

All in all, this suggests plenty of new work for those involved in the sector, and is a rare optimistic note in a financial services industry still beset by the credit crunch fallout.

Charts obtained from www.edhec-risk.com/features/RISKArticle.2008-07-23.0926

Paul Amery is the European correspondent for IndexUniverse.com. He can be reached at This e-mail address is being protected from spambots. You need JavaScript enabled to view it .