ETFs are gaining ground globally
Exchange-traded funds (ETFs) have solidified their position as one of the successful financial innovations of recent years, having become a strong alternative to mutual funds and other financial products. Since its inception in 1993, the ETF market has grown significantly, reaching USD 3.2 trillion in assets worldwide in August 2016.1 The European ETF industry represents USD 533 billion2 in assets and has tripled over the last 10 years.
Based on client demand for low-cost products, the ETF market will continue to grow rapidly, perhaps doubling in size within the next eight years. Additionally, it is likely to experience tremendous innovation for years to come, with new asset classes, new investment styles, and new international investment opportunities.
Actively managed ETFs represent the next generation of innovation. With such ETFs, rather than simply replicating a particular index, managers may continually change the underlying index, like an actively managed mutual fund. What's more, investors have a large variety of choice when purchasing ETFs.
The quickly growing robo-advisory business is increasingly using ETFs to offer simple and low-cost investment solutions to clients. By utilising ETFs, robo-advisors can automate the investment process as much as possible for a very low cost (estimated from a 0.25% to a 0.3% annual fee). With this business model, a new client signs up online and answers a series of questions to assess his or her investing style; the robo-advisor then plugs the answers into an algorithm that constructs a portfolio of ETFs based on the client's needs, after which the money is automatically transferred from the client's bank account to his or her investment account.
ETFs in Luxembourg
Luxembourg, as Europe's number one fund domicile, has got the platform for cross-border fund distribution, a highly experienced regulatory authority, an efficient tax environment, a multilingual and international workforce and a unique concentration of specialised service providers. Luxembourg UCITS are distributed in more than 70 countries around the world, across Latin America, the Middle East and Asia in addition to Europe and North America. They are highly regarded.3
To strengthen its position as one of the world's most attractive investment fund centres, it is key for Luxembourg to increase its reputation and market share in the growing ETF business and get rid of common misperceptions.
Currently, Luxembourg-domiciled ETFs represent 20%4 of the European market and ETF promoters such as Amundi, Credit Suisse, Commerzbank, Deutsche bank, Lyxor, and UBS have ETFs in Luxembourg. Not everyone knows that ETFs are, under certain conditions, exempted from the annual subscription tax. The main disadvantage of Luxembourg compared to Ireland is its less favourable double taxation treaty with the US, which makes the taxation of US investments a bit less favourable.
However, Luxembourg has its own strengths to assert: it is better, in the current tax environment, to have the management company domiciled in the same country as the fund and to thereby align the substance of the fund and its management in one jurisdiction. For those asset managers whose management company is in Luxembourg, this may be a key argument for setting up their ETF in Luxembourg too. In addition, of course, is Luxembourg's fantastic distribution network and extensive double tax treaty network.
What do investors like about ETFs?
Below are some advantages that retail and institutional investors can get from ETFs as compared to mutual funds actively managed:
- Fees: ETFs typically have lower fees than comparable mutual funds. This is because the cost of shareholder servicing and recordkeeping is largely eliminated for ETF sponsors.
- Investor objectives: ETFs are well suited for investor objectives related to portfolio diversification, liquidity needs or hedging.
- Intraday trading: ETFs are continuously valued throughout each trading day, and the price of an ETF share is market-derived.
- Liquidity: ETFs can be bought and sold at any time during the trading day, just like a stock. This liquidity factor is particularly important to institutional investors (e.g. pensions) as they can use it to park money for short periods of time.
- Taxes: Both ETFs and mutual funds distribute realised capital gains every year to minimise or eliminate entity level taxes. But in practice, ETFs often distribute fewer capital gains than comparable mutual funds due to ETFs' ongoing redemptions of investors in kind.
- Access: ETFs offer cost-effective access to an array of investment options for any investor with a brokerage account, as well as the ability to short-sell for investors looking for the inverse exposure of an ETF.
- Transparency: ETFs generally must disclose their holdings on an intraday basis, while mutual funds generally have to do it quarterly. While this places an administrative burden on the ETF sponsors, it's a benefit for investors.
The ETF playbook
Just because there will be more assets does not mean there will be room for everyone to play. The so-called "big three" (Blackrock, Vanguard, State Street) control around two-thirds of the ETF market. Out of the 204 ETFs launched in 2014, 92 have gained less than USD 10 million in assets, a 45% flop rate.5
Whether you are considering entering the ETF market for the first time or expanding your existing ETF offerings, it is imperative that you have an effective strategy, technology and operational components in place, a product that connects with investors distributed through a channel that has the right technology and expertise.
This ETF playbook has been designed to provide practical insights to help compete and enhance your plans for success in the growing and highly competitive ETF market.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.