USD2 trillion question: Why ETFs have failed to catch fire with UK platforms & advisers?
Exchange traded funds (ETFs) have been a monumental success since the first US listing in 1993, says Alex Kerry, (pictured) head of Winterflood Business Services.
In 2005, there was USD425 billion AUM in ETFs globally – by August 2015, this had grown to over USD3 trillion. ETFs attracted net inflows of USD372 billion in 2015 alone. The pace of AUM growth as well as the pace of ETF product development has been blistering.
However, in the UK, the explosive growth of ETFs is limited predominately to the institutional arena. What we have not seen is the rapid adoption of ETFs in retail markets and among advisers as witnessed in the US. Many UK advisers remain entrenched in the use of active vehicles. This situation is even more curious when you consider S&P data that shows actively managed UK equity funds have routinely failed to beat their benchmark, with three-quarters of managers in this category underperforming over the past decade.
ETFs have become increasingly important in a world where investors want greater transparency, lower cost and choice. So the question must be: why has the ETF market failed to catch fire in the UK, while the market for ETFs in the US has surpassed USD2 trillion?
We believe there are two key issues that have held back the adoption of ETFs by platforms and advisers: access and education.
A fundamental lack of education
Unfortunately, there has been a failure from providers and other key industry knowledge brokers to successfully explain the advantages of ETFs to advisers. There remains a fundamental lack of education. Many investors do not have a full understanding of how these simple, transparent and cost-effective vehicles can be used effectively in portfolio construction – from core allocation to more sophisticated tactical exposures across the spectrum of asset classes. As the investing world has shifted from a bottom-up to a top-down allocation approach, the ETF market is providing products that enable asset allocators and advisers to flourish.
First generation ETFs provided investors with relatively standard asset and index exposures, but now ETFs are going beyond traditional index exposures, offering baskets of securities filtered by risk factors and strategies. They also track a spectrum of hard and soft commodities. In turbulent times for investors, the breadth of ETF options can increase diversification options.
There also needs to be more recognition of the increased tradability and transparency ETFs can provide. ETFs can provide an additional layer of liquidity and pricing transparency than mutual funds. They are continuously priced throughout the trading day, and investors buy and sell them in the secondary market.
Lack of infrastructure is a barrier to access
One of the reasons that a significant number of advisers don’t use ETFs is simply because they don’t have access to them. To put it bluntly: You can educate advisers, but if they haven’t got the materials or the capability to deal them, they will not get far. In a number of cases, platforms simply do not have the infrastructure to provide exposure to exchange traded instruments – and when they do, they are expensive to access.
The challenge is being made more difficult by an engrained culture whereby advisers are choosing to stick with familiar fund structures, such as unit trusts or OEICs. Indeed, even if the platforms provide the requisite technology, ultimately the demand from adviser and discretionary markets must be there. Many advisers can be forgiven for lacking a deep understanding of the complexities of the ETF market but once infrastructure has been improved to include ETFs, it is incumbent on providers to improve their education. This knowledge can then be passed down to underlying investors.
Advisers say they are reticent to access ETF vehicles due to broker charges. However, these costs can be reduced by improving infrastructure and aggregating trades. We are working with platforms to reduce dealing charges for advisers and DFMs by providing aggregation services. Platforms can integrate cutting-edge services to existing infrastructure that widens the asset reach to create more diversified and cost-efficient portfolios for underlying investors.
A more mature US market
It must be also said that the US market is more mature. It has undergone far greater regulatory harmonisation than Europe. It has also adopted a fee-based model far quicker, removing incentive structures that were previously present in the UK market. This has created a more objective appraisal of investment products. We are now beginning to see the fruits of RDR in the UK as the playing field of different types of products levels – and, furthermore, the switching off of all trail commission by 6 April 2016 via the 'sunset clause' should create another catalyst for a pick-up in interest from advisers. While a lot of assets have now been transferred to clean share classes, the movement of legacy assets on platforms once the deadline hits may see a switch into passives and ETFs as advisers face greater pressure on pricing and transparency.
ETFs have reshaped the investment world and widened the spectrum of asset classes available to investors; a lack of education and access should not be the reasons for advisers and platforms to ignore these products. Ultimately, this will deprive the underlying investor of the full suite of investment tools – something which is against the spirit of RDR. It is not simply a question of active versus passive or one fund structure versus another: it is about choice.