A Year Of Firsts In The ETF Industry

[This article was first published on The Asset, a financial publication based in Amsterdam]

What a year.

2014 proved to be another year of tremendous growth and innovation for the European exchange traded fund (ETF) industry, which launched over 200 ETFs in Europe and raised $62 (€57.4) billion of net new inflows. This success is set to continue this year as assets in Europe-listed ETFs have hit over $500 billion as of last month, and global assets have broken the $3 trillion barrier, announced this week.

ETFs are revolutionary in their simplicity - they are funds that track an index and trade like a stock. The industry’s growth in 2014 has broadened the horizon of the average ETF investor, who no longer has to resort to expensive actively managed funds or investment trusts, and can now access niche and specific sectors and asset classes all via a low cost, transparent and publicly traded fund. From very short-dated, currency hedged bonds to mainland Chinese equity markets, a whole new world awaits the investor and their portfolio.

And it’s not just exposure – ETF providers have continued to cut costs. Source achieved a new low when it cut its annual fees on its S&P 500 ETF to just 0.05 percent in June last year.

While 2015 continues to break barriers and further open access for ETFs to global markets, investors should be reminded of the developments in 2014, which could be named the “Year of Firsts” for the European ETF industry.

Of course there is much more to discuss than can be said in one article. Our annual conference will take place next week between 8 to 10 June at the Hotel Okura in Amsterdam, where investors can network with their peers, gain continued professional development at our ETF University and sip a well-deserved cocktail in the evening.

Targeted Fixed Income Exposure

Precise and targeted fixed income exposure is becoming increasingly important to ETF investors in Europe. We are facing interest rate hikes at the same time as a global deflationary environment, record low yields or even negative yielding European government bonds - not to mention the looming unanswered question of how European quantitative easing will affect bonds in the medium to longer term.

So, where to now? Investors often have a mandate to allocate a certain amount of assets to safe haven assets, or to produce stable and reliable income.

This period of extraordinary bond yields has led to frenetic activity from ETF providers. Goodbye to broad bond indexes which rank the most indebted issuers as top holdings, and hello to specific exposures for sophisticated portfolios. Now investors have the luxury of choosing between indexes that rank bonds by anything from their quality rating to their duration and yield.

Exciting launches in 2014 included funds like Amundi ETF Floating Rate Euro Corporate 1-3 UCITS (AFRN), the region’s first and only ETF offering exposure to a basket of variable-rate, investment grade corporate bonds from the eurozone. Since launch in September, it has already grown to around €110 million in assets.

There have already been more exciting developments in 2015, including the launch of actively managed, smart beta fixed income ETFs in the government and corporate bond space by ETF Securities and Lombard Odier Investment Managers.

Currency Hedged ETFs

Who could forget to hedge their currency risk after witnessing the outcome of their Japanese investments in 2013? While the stock market soared, the yen was decimated. The MSCI Japan hedged index produced double the returns (64 percent) over the year, compared to the unhedged index.

FX volatility picked up again in 2014 to the surprise of investors, and has become one of the greatest investment themes this year – the U.S. dollar hit a 12 year high last week versus its major counterparts and the euro has tanked as the European Central Bank has set about cutting interest rates and implementing quantitative easing.

Just as well, then, that the European ETF market was inundated last year with currency hedged ETFs on various indexes. These funds allow investors to access mainstream markets from the U.S. S&P 500 to the Japanese JPX Nikkei 400 while mitigating the risk that the local currency could swing against them and harm returns.

Currency hedging has really taken off in fixed income, too. One example is the UBS Barclays US Liquid Corporates 1-5 UCITS ETF (hedged to EUR), which launched in April 2015, following the successful launch of sterling and swiss franc hedged versions the previous year. This fund tracks short dated bonds, which are less sensitive to interest rates, and hedges returns into euros, in case investors do not want to continue to bet on a rising dollar.

In fact, most European-based providers have set about to provide investors with more currency hedged funds that use one-month forward contracts to mitigate FX risk, but investors should be warned this tweak does not totally banish FX impact from returns.

And remember FX swings can seriously undermine profits: for example, the All Country Europe Index gained around 14 percent over the past 12 months to 8 April 2015, but any U.S.-based investors who did not hedge their returns to the U.S. dollar would have made a net loss of 4.29 percent, according to MSCI and ETF.com data.

Access To China

Although China is often regarded as a global economic powerhouse and especially within emerging markets, foreign investors had little access to its mainland equities before 2014 due to restricted access to from Chinese authorities. ETF investors were limited to either synthetically replicated funds or direct access to offshore, Hong-Kong based companies.

The birth of the physically replicated A-shares ETF market in Europe was one of the most exciting innovations of the year, and spawned four product launches in quick succession. First came Source and db X-trackers in January, followed by ETF Securities in May and Lyxor in September, for as cheap as 0.85 percent per year. Rumour has it that other providers like HSBC are considering weighing in on this market also.

Depending on how concentrated you wish your A-share exposure to be, indexes on offer are the FTSE China A50, the broader CSI300 Index and MSCI China A Index, all of which have a heavy skew to financials. Demand for the products soared in 2014 to the extent that db X-trackers had to temporarily limit ETF unit creations as it ran out of quota from the Chinese authorities.

The db X-trackers Harvest CSI300 UCITS ETF (RQFI) has returned over 120 percent in sterling terms in 12 months to 8 April – clearly this is a sector that has paid off handsomely to investors.

Thanks to this new China access, equity ETF investors have the luxury of picking single countries around the world for their portfolios, from Indonesia and Pakistan to Mexico and Brazil.

Top 5 New Fund Launches In 2014

1) Source CSOP FTSE China A50 UCITS ETF

A groundbreaking ETF, this was the first physically-backed China A shares ETF to launch in Europe. It tracks the most liquid mainland index in the world, the FTSE China A50 index, which has the backing of a strong derivatives market.

2) ETFS ROBO-STOX Go UCITS ETF

Who knew that robots were an investable universe? This fund specifically targets companies engaged in robotics and automation from around the world.

3) PowerShares Global BuyBack Achievers UCITS ETF

This ETF is the only alpha-seeking ETF in Europe that is specifically focused on corporate buybacks. The fund invests in global companies that have seen a net reduction in shares outstanding by 5% or more over the past 12 months in order to improve shareholder value.

4) WisdomTree EM Small Cap Dividend UCITS ETF

This fund offers a different take on emerging markets small-caps: it selects and weights its holdings by dividends: a perfect fit for income-seeking investors.

5) SPDR Global Convertible Bond UCITS ETF

Welcome to the first European listed convertible bond ETF. It targets a broad basket of investable and global bonds which can be converted to equity.