One of Ireland’s lesser-known achievements in recent years has been establishing itself as the European domicile of choice for exchange traded investment funds (ETFs), writes Philip Lovegrove.
European ETFs had almost US$475bn in assets under management at the end of February 2015 and approximately half of that is held by Irish domiciled funds. However, perhaps the most impressive aspect of the European ETF market is its potential for future growth, with some projections expecting the market to treble in size by the end of the decade. The good news is that Ireland is well positioned to harness this potential.
ETFs are a type of investment fund, typically established as corporate vehicles and authorised under the UCITS directive, which provides an EU-wide framework for funds which are suitable for retail investors but available to all. Where ETFs differ from most other funds is that their shares may be purchased or sold on a stock exchange, through a broker, in the same way as any other publicly traded security.
This can result in significant advantages for the investor, such as the ability to trade throughout the day when markets are open and to trade directly with the market, which contrasts with the more traditional fund model of buying and selling shares through the fund itself and on the fund’s own timetable. Irish ETFs also benefit from all of the tax and other advantages which are available to Irish funds generally.
ADVANTAGES OF ETFS
A typical ETF provides a passive exposure to the performance of an index, which brings two principal benefits: transparency and cost. Where they are replicating a publicly available index and therefore not concerned about protecting a proprietary investment strategy, ETFs are typically happy to offer much more information about their holdings than a traditional fund provider and to update it throughout each business day.
In addition, because of the potential for savings on investment management intellectual capital and the large size of many of the major Irish-domiciled funds, ETFs are typically available with very low management fees. Recent years have seen fierce competition between the major players in the ETF market on price, so that investment management fees for many of the more popular products have been reduced significantly.
These features, among others, have made ETFs increasing popular among investors and the sector has seen consistent and substantial growth. Over the last 10 years European assets under management have increased by a cumulative annual average of just under 30% and was up more than 7% for the first two months of 2015 alone.
The role which ETFs could play in active investment management may yet be the most significant development …
Unsurprisingly, this growth has lead to a lot of innovation, as product developers start to push out the boundaries of what ETFs are used for. ‘Smart beta’ is a catch-all term, which has become almost ubiquitous in ETF circles and is used to describe indices tracked by ETFs which are constructed on non-traditional lines, such as dividend yield, earnings or share buybacks of constituents, instead of basic market capitalisation.
Providers are also using Irish ETFs to give access to new geographical markets, such as China and India and to new asset classes, such as convertible bonds. However, the role which ETFs could play in active investment management may yet be the most significant development for these funds in the next five years.
Active managers are typically those that seek to implement their own investment strategy through investment selection in an effort to outperform the broader market, while passive managers try to replicate the performance of a given market or index and not necessarily to beat it.
Active managers have been investing in ETFs for years to achieve particular exposures that they think will deliver their strategy and desired returns, but they are now increasingly starting to consider the benefits of structuring their products as ETFs themselves. This will require some work, as active managers are often reluctant to provide the sort of transparency in respect of their holdings which is seen as necessary for public market trading in an ETF to function properly, for fear of giving away proprietary information.
However, these concerns should not prove insurmountable and Ireland is already moving to create an appropriately balanced market and regulatory environment to encourage this next stage. Indeed, given the vast experience of its service providers and regulators of working with cutting edge products and implementing innovative solutions to industry problems, Ireland is in prime place to support these innovations and continue its position at the centre of the ETF market in Europe.