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Changing face of the ETF market

Has the pandemic altered the growth trajectory across southern Europe?


Cherry Reynard

At the start of this year, Morningstar predicted that the European ETF market could hit €1trn by the end of 2020 and €2trn by 2024.

It based this view on the four-fold expansion in the use of ETFs seen since 2009.

Markets such as Italy had been vitally important in the spread of ETFs in Europe.

But, to what extent has the pandemic changed the landscape of the ETF market in southern Europe?

Hot on its heels

The ETF market across Europe has been dominated by equity.

As at the start of January, equity ETFs still represented around two-thirds of ETF assets under management across Europe and the make-up of the Spanish and Italian markets reflected this trend.

Equity AUM had been supported by strong flows into domestic European equities in the second half of 2019.

That said, fixed income ETFs were hot on their heels, more than quadrupling over the preceding five years.

This had been driven by improvements in the construction of bond indices, addressing the valid criticism that market-cap weighting indices tended to be have large holdings in the most indebted governments and corporates.

The overall success of ETFs has had a number of drivers: an increased regulatory focus on cost pushed investors towards low-fee options, the changing nature of the advice market under Mifid II – away from commission and towards a fee-based model – also favours ETFs.

There was also plenty of innovation and new products coming into the market, even though the lion’s share of the flows still went into ETFs tracking the ‘vanilla’ indices.

Ebbs and flows

The pandemic has proved disruptive and may yet change the balance of ETF assets in southern Europe.

Italy, for example, had been a receptive market for ETFs, but it shed €22.84bn in March alone, with the majority of the outflows split evenly between equity and fixed income ETFs.

Each lost over €12bn.

Only money market and, surprisingly, commodities saw positive inflows over the month.

In Spain, which remains around one-seventh of the size of the Italian market, outflows were €2.43bn, with equity suffering most, but fixed income close behind.

However, it was notable that, in Italy fixed income ETFs recovered all of their outflows in the next two months and then added the same again in June and July to put them significantly ahead for the year.

Assets in fixed income ETFs now total €211.02bn, compared to €195.89bn at the start of the year.

They are now 28% of overall assets in ETFs, up from 25% in January.

In Spain, equity ETFs continued to bleed assets through March, April, May and June, dropping €3.66bn, only returning to positive flows in July.

It was commodity assets that reaped the benefits, rising from 13% to 16.5% of overall ETF assets.

Fixed income assets, in contrast, increased market share by around 1.5%.

Fixed income push

Michael John Lytle, chief executive at Tabula Investment Management, believes that equity investors have largely gone through their adoption of passive funds, with around 20-30% of equity assets now managed passively.

“Fixed income passive funds currently only have around 5% of the market,” he said.

“We believe we could see similar levels of growth as that seen in equity ETFs and possible more because fixed income is a larger market.”

Tabula entered the Italian ETF market this month with the listing of its European investment grade bond strategy on Borsa Italiana.

“This year, fixed income has completely outpaced equities…Italy is now 10% of the European ETF market, up from 7% and around half of its flows are into fixed income. Other geographies may be more important in size terms, but Italy is seeing stronger growth.”

These flows are heading mainly into corporate credit strategies – investment grade and high yield.

Retail lagging behind

European institutional investors have led the charge and continue to be the main buyers of ETFs.

Morningstar said in its recent ETF report on European fund trends: “There are no solid statistics on ETF client type, but the consensus amongst industry players is that more than 80% of ETF assets in Europe are in the hands of institutional investors, such as private banks, wealth managers, hedge funds, pension funds, and insurers.”

This is in contrast to the UK and US, where retail investors are playing an increasingly important role.

Looking to the future, Lytle believes there is likely to be considerable activity in the inflation area over the year ahead.

“There are polarised views on whether we have deflation or hyper-inflation. When there is that type of divergence, there is usually greater activity in the ETF market.”

Make it sustainable

The other area of development is likely to be in ESG.

Europe accounts for more than three-quarters of all sustainable passive funds.

Lyxor recently launched a range of ETFs aligned with the Paris Agreement goals, while BNP Paribas AM and Franklin Templeton launched two smart-beta climate ETFs in July.

As with other areas, the pandemic has not necessarily changed the direction of travel for European ETFs, but it has given existing trends greater momentum.

It has accelerated a reshaping of the southern European ETF market away from equity and towards fixed income, with gains for commodities and ESG strategies alongside.