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Climb Higher | How Asset Managers Can Compete In Europe's ETF Market

Summary

  • Concentration of assets in the European ETF market is nearing that of the U.S., raising questions from both investors and regulators
  • Lack of competition in European ETF market is damaging to the long-term success of investors, the long-term business opportunity for asset managers and the long-term health of the ETF industry
  • High barriers to entry and perceived competitive challenges are inhibiting market entry and the preventing the introduction of new offerings by prospective ETF issuers
  • Barriers to entry into the European ETF market are lowering as Europe adapts and evolves the white-label model

Introduction

Exchange Traded Funds (ETFs) have been one of the most revolutionary and disruptive investment propositions of our generation. Since their launch in Europe in 2003, ETFs have seen assets grow to -$860 billion1 and an increasing number of asset classes, exposures and strategies are now available to investors in the simple and cost-efficient ETF format.

ETFs are often described as 'democratic' products - both retail and institutional investors trade the same product in the same way with the same availability of information. The unique structure of ETFs (that connects to the underlying asset class through the "create redeem" mechanism) means that an ETF can absorb both very small and very large trade sizes without impacting the underlying market. A boon for investors, ETFs have levelled the playing field for European institutions and individuals alike.

Though ETFs may have democratised the investment landscape, the European ETF industry itself is trending towards oligopoly (control by the few). A vast concentration of assets in the largest European ETF providers, coupled with structural impediments and opaque influence networks are inhibiting innovation, raising barriers to entry and reducing consumer choice. In order for the European ETF industry to reach its full potential the barriers to entry and the impediments to success must be addressed.

What Are the Barriers to Entry in European ETFs?

The ETF model has been proven to work. Every major asset manager, bank - and some insurance companies - has or wants an ETF division. ETFs are now being understood as a disruptive distribution technology that is applicable to asset managers of all shapes and sizes, not just traditional index fund managers.

Currently, almost every major ETF provider in Europe  is linked to a broader  financial institution -  and there is a good reason. It  is expensive, difficult and time consuming to start an ETF business, especially if you are not experienced in the nuances of the market. Before a prospective issuer has even raised the first Pound/ Euro in seed they will need to invest heavily in:

  • Office space and infrastructure 
  • Legal fees
  • Talent acquisition and training
  • Index licenses
  • UCITS platform development
  • Registration and passporting 
  • Custodian and sub-custodian fees
  • Listing and exchange fees
  • Paid market making
  • Product development 
  • Marketing, branding and PR

These costs alone could reach €1-5 Million or more before the first ETF is even available to trade. On top of these essentials, a prospective issuer will need to understand the different regulatory environments across Europe, establish relationships with distributors and brokerage platforms and create a network of Authorised Participants (APs) and market makers to support the liquidity of their funds.

Large financial institutions with deep pockets can afford the cost, time and commitment to develop and launch their own ETF range in-house - we have seen juggernauts like JP Morgan, BMO, Fidelity and Franklin Templeton launch in Europe with stand alone offerings; but mid-tier and smaller asset managers frequently lack the resources and expertise to go it alone.

One alternative route to market entry would be to buy a footprint in the ETF industry by purchasing an existing ETF issuer. Legal & General took this approach by acquiring the ETF Securities Canvas platform in 2018 and, at time of writing (May 2019) there is great speculation at who may step in to buy the DWS ETF business. Of course, acquisitions are not frequently available, come with significant integration challenges and can be even more expensive than building in house, depending on the acquisition target. This option would only be available to large institutions and is not a feasible market entry strategy for most companies.

An Oligarchic Market

According to April 2019 data from ETFGI, the top 10 largest ETFs in Europe account for almost 16.3% of total assets, or -$131 billion.

LARGEST ETFS: EUROPE  AUM $m 
 iShares Core S&P 500 UCITS ETF 30,784
 Vanguard S&P 500 UCITS ETF 22,343
 iShares Core MSCI World UCITS ETF 5,476 
 iShares Core MSCI EM IMI UCITS ETF 2,259 
 iShares Core€ Corp Bond UCITS ETF 9,264 
 iShares S&P 500 UCITS ETF 8,379 
iShares JPM EM Local Government Bond UCITS ETF 8,340 
 iShares Core FTSE 100 UCITS ETF 8,223 
 iShares Eurostoxx 50 UCITS ETF 7,819 
 iShares Core DAX UCITS ETF 7,445
 % of Total European ETF Assets  16.3%

 

The distribution of European ETF assets by issuer is even more highly concentrated with the top 3 providers controlling 63% of total assets:

 ISSUER EUROPE: MARKET SHARE 
iShare 44%
Xtrackers / DWS 11%
Lyxor  8.4%
UBS 6.6%
 Amundi 5.8%
Vanguard 4.9%
SPDR 3.9%
Invesco 3.8%
ETF Securities 2.1%
BNP Paribas 1.3%

 

Should this top-heaviness be a cause for concern for prospective ETF entrants? Probably not. After all, the largest ETFs are highly commoditised 'core' exposures that have had a long time to gather assets. There is little scope for differentiation or competition in these core exposures outside of price, and only the largest companies have the economies of scale necessary to compete purely on a low-cost basis. It is unlikely that a new entrant to the European ETF market would want to launch another S&P 500 or FTSE 100 ETF (unless they were designed as a defensive move to prevent client leakage to competitors with an equivalent offering.)

Looking at the more established North American ETF market we can see even more pronounced concentration in the top ten funds, which account for 27.7% of the overall market share, with Vanguard and Blackrock's iShares again featuring heavily in the top ten. (All data below from ETFGI, as of April 2019).

LARGEST ETFS NORTH AMERICA AUM $M (March 2019) 
SPDR S&P 500 ETF Trust 266,530
iShares Core S&P 500 ETF 167,279
Vanguard Total Stock Market ETF  108,765
Vanguard FTSE Developed Markets ETF 70,368
Invesco QQQ Trust 70,297
Vanguard FTSE Emerging Markets ETF 63,798
iShares MSCI EAFE ETF 63,304
iShares Core MSCI EAFE ETF 60,232
iShares Core MSCI Emerging Markets ETF 59,291
iShares Core US Aggreate Bond ETF 59,182
% of Total US ETF Assests 27.9%

 

The U.S. ETF market is even more top heavy, with the largest 3 providers controlling 81% of total ETF assets. Does the U.S. market show the direction of travel for Europe?

ISSUER US MARKET SHARE 
iShares 39%
Vanguard 25.4%
SPDR 16.5%
Invesco 5.0%
Schwab 3.5%
First Trust 1.9%
WisdomTree 1.0%
Van Eck 0.9%
ProShares 0.8%
JP Morgan 0.6%

 

The massive concentration in the top 10 largest ETFs in North America belies a vibrant industry of smaller and mid-sized providers competing outside of the core in a variety of asset classes and strategies. There are now -129 providers of ETFs in North America vs only 60 in Europe. Looking at the most successful North American ETF launches of 2019 so far (based on ETFGI April data), we note that there are only a couple of 'big name' issuers in the top ten:  

MOST SUCCESSFUL 2019 ETF LAUNCHES - NORTH AMERICA (To March)   AUM $m 
Xtrackers MSCI USA ESG Leaders Equity ETF 872
Virtus Real Estate Income ETF 193
Virtus Private Credit Strategy ETF 164
Innovator S&P 500 Power Buffer ETF 92
Aware Ultra Short Duration Enhanced Income ETF 89
ARK Fintech Innovation ETF 57
Syntax Stratified Large Cap ETF 48
RYZZ Managed Futures Strategy Plus ETF 39
Innovator S&P 500 Ultra Buffer ETF January 39
iShares Focused Value Factor ETF 32

 

The U.S. market illustrates that a smaller ETF issuer can achieve significant success with the right product  for the market and that innovation in the ETF industry is frequently driven by the mid and smaller tier players. But, as one swallow doesn't make a summer, one successful ETF does not guarantee a sustainable ETF business. And this is where smaller asset managers are at a disadvantage relative to the giant players:

Double Edged Sword of Innovation: Smaller asset managers need a distinctive approach or strategy to differentiate themselves in a crowded market. The risk is that a larger issuer can copy their idea, quickly create a 'me too' strategy and roll it out at lower cost - effectively bypassing the need for either innovation, bravery or R&D, destroying competition.

Cost of Failure: Were iShares, SSGA or Vanguard to launch an ETF that gathered no assets, they have enough revenues from their other products to shake-off the loss. A manager with only one or two ETFs does not have this luxury.

Marketing Power: It takes time, significant investment and hard-to-find skills to build a pan-European ETF brand and marketing infrastructure. Establishing an ETF marketing capability with scale could cost upwards of £500,000, not including staffing costs. Large ETF players benefit from the influence that their order flow, AUM-based index license fees and advertising buying power to negotiate marketing 'contributions' from their service providers that can run into $ millions- contributions that are not extended to smaller players.

Distribution Power: The complexity of ETF distribution in Europe (different languages, regulators, currencies, distribution platforms, exchanges and liquidity providers) can make it difficult for new entrants to gain traction. This can create a vicious cycle whereby low assets and trading volumes prevent platforms from adopting ETFs, which in turn, make it harder to gain assets and generate liquidity.

Shareholder and Lobbying Power: With well-staffed Government Affairs teams and influence over $trillions of assets, larger ETF issuers can have disproportionate impact on both regulatory direction and corporate behaviour. When a large manager of active and passive funds can be invited to Davos, advocate for wider ESG integration in public letters and simultaneously push an ESG fund range, the lines between activist investment and index investment begin to blur to the detriment of smaller market participants who hold less sway over policy and regulatory decisions.

Different Markets, Different Distribution Partners

The relative success of small and mid-tier issuers in the US market may give comfort to prospective European issuers who are thinking of launching an ETF, but the differences in market structure, distribution channels and investor mindsets can make a significant difference to the survival and success of an ETF.

The U.S. is a homogenous market with one currency, one regulatory environment, a consolidated tape and only a few exchanges listing ETFs. Investors well versed in self-directed investing via 401Ks and other personal investment schemes means that there is a high degree of retail investment literacy, a strong brokerage culture and a distribution structure that revolves around RIAs (Registered Investment Advisors) and Wirehouses (large broker-dealers such as Charles Schwab, Morgan Stanley, Merrill Lynch and UBS.) Placing an ETF on one of these platforms makes it instantly visible and tradable to almost the entire addressable domestic investor market. No such mechanism that provides a continent-wide shopfront is available in Europe.

Advertising can reveal a lot about a market. If you visit New York, Chicago or Boston you will see plenty of adverts from ETF issuers on TV, radio, billboards, subways and mainstream news and investing websites. In contrast, in Europe you rarely see an ETF advert outside of the industry media. This difference in promotional activity can be explained by the different audiences that issuers are trying to target, and the relative investment literacy of the markets.

The U.S. ETF market is estimated to be split 25:75 between institutional and retail investors. In contrast, Europe is predominantly an institutional market (although retail is growing fast and some countries, like Italy, have a high retail participation) that requires a different type of marketing and sales strategy- the decision-making process for an institution to on board an ETF is far more extended and complex than an individual investor simply opening up their brokerage app on a smartphone or clicking on a banner ad.

Historically, European fund distribution and wealth management have been heavily influenced by domestic banks and each country had a different bank(s) that were important to work with to establish market footprint. The legacy of this structure can still be seen in the top 4 largest European ETF Issuers, all of whom benefited from being owned by banks and therefore able to quickly gain geographically specific market share by distributing their own products to a captive audience: iShares & Barclays (UK), DWS & Deutsche Bank (Germany), Lyxor & Societe Genera le (France) and UBS (Switzerland).

Since the inception of European ETFs, the distribution landscape has become more complicated. Instead of a handful of wire houses, European ETF issuers must contend with more than 20 exchanges and a massive array of different local platforms, each with their own due diligence, eligibility criteria, onboarding process and costs. As you can't sell a product that's not on a shelf, an ETF issuer will need to know, engage with and onboard with dozens of platforms in many countries - an intimidating task for the uninitiated.

On top of this, there are a growing number of wrap platforms, local brokerages, model portfolio providers, ROBO advisors and advisor networks that also need to be targeted. Knowing where and how to get started in such a fragmented, complex and confusing landscape can be very challenging for companies that lack European ETF experience, but getting it right can be the difference between a successful fund and a failure.

ETFs As Distribution Technology & Impact on Investors

Developing an ETF range which can be offered alongside other structures like mutual funds, structured products, separately managed accounts or investment trusts is a high priority for many European asset managers.

Just as a coffee company can sell their product as beans, ground coffee, pods, instant powder or pre-mixed iced coffee, so can an asset manager add to their distribution firepower by adding an ETF category to their product range. Many will already offer multiple wrappers including mutual funds, hedge funds, structured products and so on. Adding ETFs is simply extending this foot print.

Without an ETF range, asset managers risk being excluded from the many distribution channels that are focused on ETFs and will be at a significant competitive disadvantage to managers who recognised the distribution potential of ETFs earlier on. While many investors have replaced expensive, clunky index mutual funds and 'closet trackers' with ETFs, there are currently, limited options for investors to perform the same exercise for the actively managed  portion of their  portfolios  -  but this is changing  fast

Traditional fund managers can benefit from this by giving investors (who may have strong brand loyalty to a particular fund provider) the opportunity to buy the strategies they like in ETF format - offering significant improvements to their current experience by adding liquidity, tradability and lower entry and top-up rates.   

Imagining a More Diverse European ETF Market

A more diverse ETF market will benefit investors, asset managers, exchanges and fund selectors alike:

  • Number of ETF issuers increasing and de-concentration of assets
  • Traditional asset managers re profiling successful strategies as ETFs
  • Active managers launching ETFs
  • More innovative strategies and niche exposures (that larger, more conservative institutions may not be willing to launch) 
  • Further cost reductions for core exposures and introduction of more higher bps value-adding strategies 
  • Greater choice for fund selectors so that they can reduce dependency on a handful of counter parties 
  • Increased competition in indexing and downward cost pressure on index license fees 

The first step to achieve this vision is for asset managers to break the link between ETFs and indices and reconsider ETFs as a disruptive distribution technology that is applicable for any (liquid) asset class, passive, systematic or active strategy. (Our previous paper "Win the Future" covered this issue in more detail). As a distribution wrapper, ETFs have the potential to transform the ability of asset managers to deliver their investment IP - including active strategies - to a much broader audience than was possible with traditional funds.

De-Risking and Breaking Down Barriers to Entry

When € Millions are needed simply to get to the point of launch, the risk of going it alone may be too much for many asset managers to face. So why do so many U.S. asset managers feel empowered to take the leap when European peers do not? Is there a less risky way to enter the market? Enter the white-label provider.

The White-Label Advantage

U.S. asset managers have been able to take advantage of white-label ETF platforms for a number of years. These platforms provide all the necessary regulatory, operational and capital markets infrastructure to manage an ETF meaning an asset manager can 'plug in' and bring an ETF to market quickly, and at a significant cost saving compared to going it alone. This model also makes it economically viable for asset managers who may only want to launch one of two ETFs but do not want to invest in their own infrastructure. With less set-up costs, U.S. mangers can focus more on distribution, marketing and sales - services that are not typically offered by U.S. white-label platforms.

With dozens of ETFs now available via white-label platforms, the experience of the U.S. shows that there is a wave of new investment ideas that investors want to  buy, that can be unleashed in an ETF format  and that can carve out distinct  niches  in the face of the giant issuers with the right idea at the right time. And while platforms do not guarantee a successful ETF, they can, at worst, decrease the cost of failure.

The primary advantages for asset managers using a white-label platform are:

  • Cost efficiency - massive reduction in cost-to-market
  • Rapid market entry - by leveraging an existing infrastructure, an ETF can be brought to market in ~8 weeks
  • Large scale - with an existing sales, distribution and marketing infrastructure, white-label platforms can offer broad reach and high scalability from day one
  • Small scale - managers who want to launch only 1 or 2 ETFs can do so economically via a white-label provider 
  • Expertise - clients without experience in the nuances of European ETFs can gain immediate access to experienced sales, distribution, capital markets and marketing professionals
  • Focus - outsourcing the day-to-day management of an ETF enables asset managers to focus on developing and refining new investment propositions 

With the launch of HANetf in 2017, Europe gained its first independent white-label ETF platform, opening the gates for a wave of innovation and new participants in the European market. Given the fragmentation of the European marketplace, and the differences between ETF and Mutual Fund distribution, HANetf provides not only a UCITS ETF platform but also an embedded sales, marketing, distribution and PR capability, giving on-platform funds the greatest chance of success by providing an experienced pan-European sales team and sophisticated digital marketing infrastructure from day one.

The impact is already being seen as the barriers to entry diminish - as of April 2019, HANetf has launched 5 ETFs with 3 asset managers, each with very different businesses and approaches:

The first, EMQQ / Big Tree Capital: was an established U.S. based ETF issuer and active fund manager that wanted to bring a successful U.S. listed ETF to Europe in UCITS format.

The second, Gins Global Index Funds is an established U.S., Africa and Asia-based provider of traditional index mutual funds that wanted to future-proof their business by offering ETFs and extend their geographical reach into Europe.

The third, KMEFIC is a Middle-Eastern asset manager with no experience in ETFs that wanted to extend their footprint into Europe and diversify their offering into ETFs.

Conclusions

"Any colour, as long as it's black" is hardly a choice. The concentration of ETF markets in both Europe and U.S. is a negative for investors, fund selectors and asset managers in equal measure.

Fortunately, the competitive landscape is changing - while the battle is largely won for ETFs 1.0 - equity index tracking core exposures; the battles for ETFs 2.0 (Smart Beta) and ETFs 3.0 (Thematic and Active) remain undecided and provide a huge opportunity for creative asset managers to gain traction and find success.

The advent of white-label ETF platforms in Europe, like HANetf, are game-changers for asset managers that want to establish a European ETF footprint without the cost, complexity, risk and time commitment that would otherwise be part and parcel of launching an ETF. Simply put -you no longer need to know about ETFs to have a successful European ETF business.

White-label platforms are a force that is helping to reshape the European ETF industry, bringing real democracy to the world's most democratic investment industry.  

About HANetf

HANetf is an independent ETF specialist working with third-party asset managers to bring differentiated, modern and innovative ETF exposures to European investors. Founded by two of Europe's leading ETF entrepreneurs, Hector McNeil and Nik Bienkowski, HANetf provides a complete operational, regulatory, distribution and marketing solution for asset managers who want to successfully launch and manage UCITS ETFs.

HANetf White-Label Platform

Download the complete whitepaper "Climb Higher | How Asset Managers Can Compete in Europe's ETF Market" here.

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We have also reviewed all key third party agreements where EU personal data is being processed to ensure they are GDPR compliant and that your rights described herein are being protected.

4.What safeguards we have in place

HANetf has security measures in place to protect the loss, misuse and alteration of the information under our control. As no data transmission over the internet can be guaranteed as 100% secure, we cannot ensure or warrant the security of any information you transmit to us and you transfer the data at your own risk. We endeavour to use appropriate security measures, including systems security, backups, business recovery and breach notification procedures, monitoring and testing procedures.

Although we will do our best to protect your personal data, we cannot guarantee the security of your personal data transmitted to our Site and accordingly any transmission is at your own risk. However, once we have received your information, we will use all appropriate procedures and security measures to try to prevent unauthorised access to or disclosure of your personal data.

5.What rights you have with regards to your personal data we process

You have the right to access your personal data and request a copy of the information held by us about you. You also have the right to ask for your information to be transferred to another organisation or to yourself. Where such requests are manifestly unfounded or excessive, we will inform you and we may charge a reasonable fee or refuse to respond to such a request.

You have the right to ask us not to process your personal data for marketing purposes. We will inform you if we intend to use your personal data for such purposes. You can exercise your right to prevent such processing by contacting us directly. You can also exercise the right and change your marketing preferences or restrict any specific uses of your personal data at any time by contacting us.

The accuracy of your information is important to us. We review the information we hold to ensure it is up to date and accurate. You have the right to correct any inaccuracies in the details we hold about you – if you change your email address or notice any other information we hold is inaccurate or out of date, please contact us. You have the right to obtain without undue delay the rectification of any inaccurate personal data concerning you.Your rights to access, rectify, erase or restrict your personal data stated above will be processed by HANetf usually within 30 days of receiving your request. However, HANetf may notify you within such timeframe of an increased time period to process your request and its reason. Where HANetf believes the request is unreasonable it shall notify you and refuse to process your request.

6.Complaints

If you have any questions regarding this Privacy Policy and our privacy practices you can contact us via email at [email protected] or in writing to Compliance, HANetf, City Tower, 40 Basinghall St, London EC2V 5DE.

7.Contact information

If you believe your personal data has been processed by HANetf in a way that does not comply with GDPR, you have the right to lodge a complaint with us directly [email protected] or with a supervisory authority.

If you believe HANetf did not take action on a request you have sent; or informed you without delay and at the latest within one month of receipt of the request of the reasons for not taking action and on the possibility of lodging a complaint with a supervisory authority and seeking a judicial remedy, you have the right to lodge a complaint with a supervisory authority.