Financial Services Ireland

Competitive ETF landscape offers growth opportunities

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Competitive ETF landscape offers growth opportunities

In this article first published in the July 2014 issue of Finance Dublin, Lisa Kealy, Head of Regulated Funds, discusses how tighter margins and increased competition mean ETF providers are simplifying their operations to achieve economies of scale. This in turn is creating a big opportunity for service providers to help ETF providers improve their platforms.

Asset managers around the world are putting unprecedented effort into developing robust enterprise-wide investment operations. The industry’s post-crisis push for stronger efficiency, risk management and governance is a key driver of this process.

EY’s recent survey Managing complexity and change in a new landscape: Global survey on asset management investment operations shows that other factors are also at work. As asset managers pivot towards long-term growth, the need to boost distribution and develop new products has become the primary driver of operating models and many asset managers see effective data management as becoming increasingly important to a range of their core activities.

Narrowing our focus to the global exchange traded fund (ETF) industry, we see very similar dynamics at work. The  strategic priorities shaping ETF operating platforms – growth, efficiency and stronger governance – are identical to those of other asset managers. In the same way, the changes ETF providers are making to their operating models have a lot in common with the wider asset management industry.

The ETF industry has been one of the fastest growing and most exciting sectors of asset management in recent years. The global ETF/ETP industry now manages more than US$2tn on nearly 60 exchanges worldwide. We expect global expansion in ETF assets to continue, with the potential to surpass the total level of hedge fund assets within the next two years.

In Ireland we are set to see more than our fair share of this growth as leading providers continue to set up in Europe. Ireland’s leading position as the domicile of choice for ETFs in Europe goes from strength to strength each year and currently stands at 44% of the European ETF market by assets under management.

The wave of new entrants to ETF markets means that competition is becoming ever fiercer, especially for the industry’s flagship index tracking products. Margin pressure is particularly intense in the US, where large players commonly use price wars to grab market share.

As major US promoters lead the charge into Europe and Asia, worldwide levels of competition are only likely to grow. Europe has seen a particular flurry of new entrants in recent months. Wisdom Tree’s acquisition of boutique promoter Boost and Warburg Pincus’ strategic investment in Source follow the comparatively recent entry of US giants State Street and Vanguard. The new arrivals will only add to existing pricing pressure. Established European players such as UBS, Lyxor and DB X-trackers have all recently secured additional inflows following fee reductions.

In response to margin pressure, ETF providers are taking steps to simplify their operations and achieve economies of scale across the organisation. Product rationalisation is one area of focus. The importance of fund launches to ETF inflows and the costs of fund closure mean that promoters have often chosen to keep underperforming funds open. However, increasing competition means that firms are becoming more willing to close uneconomic funds. In the US, funds are increasingly likely to be closed within 18 months if they fail to achieve the necessary scale. European promoters are becoming more ruthless too, although new entrants are likely to give their funds longer to grow.

As well as closing sub-scale funds, ETF promoters are increasing the time and money they invest in funds at the pre-launch stage. Seeding is particularly important to ensuring that new funds are launched at an attractive level of assets under management. The aim is to open fewer, more successful funds, helping to achieve a smaller, more profitable product portfolio.

Reducing fund listings is another potential source of efficiency. The opportunities for savings are particularly attractive in Europe, where many funds are listed on as many as five or six exchanges. Providers typically consider two or three listings to be the ideal
number, but firms often hesitate to reduce listings for fear of limiting investor access.  Strong inflows from Italian listings over recent periods illustrate the potential downside of focusing purely on major exchanges like London, Frankfurt or Zurich.  Firms need to compare different listings in a consistent way, helping them to balance potential growth
against potential savings.

ETF providers are increasingly putting technology at the centre of their drive for stronger, more efficient investment operations. This creates a virtuous circle, since consistent operating models make it easier for firms to harness the power of technology. Centralised improvements in technology are most likely to deliver worldwide benefits.

The importance of speed in ETF markets underpins the industry’s need for robust technology, and increases the potential benefits it can deliver.  Real time data is central to delivering the ETF performance promise, differing significantly from the daily liquidity and
reporting requirements of mutual funds.

Even the largest mutual fund managers tend to find the need for speed a major challenge when entering the ETF arena. The unique features of ETFs mean that service providers have a particularly important role to play in the industry. The strongest administrators do more than simply helping promoters to run their businesses. By supporting their strategies for innovation and expansion, they act as an enabler of growth for the ETF industry as a whole.

ETF promoters need to look to the future and develop operating models that will not only help them to achieve their current goals, but also provide them with a flexible and dependable basis for future development.  This in turn creates a huge opportunity for service providers that can help promoters to achieve their objectives.

Targeted investment in technology and skills will enable promoters and service providers alike to maximise their exposure to the global ETF market’s huge growth potential.

Lisa Kealy

Wealth & Asset Management, Sector Leader
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