The success of exchange traded funds (ETFs) in the US has caused exchanges, asset managers, index providers and other market particpants to want to launch them in Europe.
The first ETF was launched in the US in 1993. By 1997 there were 19 ETFs in the US with $6.7bn (e7.6bn) in assets. By 19 October this year there were 92 ETFs in the US with assets of $69.6bn and an average daily share volume of $6.1bn. Based on June 2001 13F reports, 911 institutions reported holding at least one US-listed ETF, up from 448 institutions in June 2000.
The first ETF in Europe was launched in April 2000. From zero just over 18 months ago, there is now $3.9bn invested in 50 ETFs with 70 listings on six exchanges in Europe (see exhibit 1). This growth rate has been impressive when compared to the US, where it took just over six years for the same number of ETFs to be launched and three years for assets invested in ETFs to reach $3.9bn.
At year-end 2000 there were six ETFs in Europe with assets of $675m. Assets have since grown to $3.9bn with an average daily share volume of $176.9m.
ETFs are essentially index funds that are listed and trade on exchanges like stocks; ETFs have opened a whole new panorama of investment opportunities to both individual investors and institutional money managers. These new instruments enable investors to gain broad exposure to entire stock markets of different countries and specific sectors with relative ease, on a real-time basis and at a lower cost than many other forms of investing. These investments are subject to market risk and will fluctuate in value. Uniquely for mutual fund type products, ETFs can also be used to short an index. They can be purchased on margin, are lendable and are purchased on a commission basis just like any other US share
ETFs are bought on a commission basis just like any other share. They can be bought and sold at market, limit or as stop orders. They do not have any sales loads, although they do – like mutual funds – have annual expenses that range from 0.30–1%. ETFs have some of the lowest expense ratios among registered investment products.
ETF products can be used to implement sector rotation and sector allocation strategies. There are currently four sets of sector products in Europe:
q ETFs can be used to hedge sector, country or regional exposure. ETFs can be sold short to hedge a portfolio of stocks. This allows an investor to preserve a portfolio while protecting it from overall market losses.
q ETFs tend to trade at or close to their underlying NAVs. This is because there are arbitrageurs waiting to take advantage of a significant premium or discount relative to the underlying index. An arbitrageur will buy/sell the ETF and place an offsetting buy/sell transaction in the underlying basket of component stocks or futures.
q ETFs enjoy several trading advantages over traditional funds. They provide investors with trading flexibility (investors can buy and sell them like stocks at stated intraday market prices), are marginable, lendable and can be shorted. In addition, stop orders and limit orders – which allow an investor to specify the price of a transaction – can be placed on ETFs
q ETFs afford investors two forms of liquidity: trading the shares on a secondary basis on the exchange and via the ‘creation unit’ process where an ‘authorised participant’ purchases the underlying basket of shares in the local market and deposits the basket ‘in kind’ into the ETF creating more shares in that ETF. The unique creation/ redemption process means that the liquidity in the ETF is driven by the liquidity in the underlying shares.
Small performance differences between an ETF and the index it tracks can be due a number of factors incluing: fund fees and expenses, a slight premium or discount, tracking error because of optimised replication of the tracked index, rebalancing due to index changes, the dividend reinvestment policy of the fund, and non-concurrent trading – for example, when the US market is closed an ETF listed on a European exchange tracking a US benchmark is trading.
Investments in ETFs are transparent. The components of the ETF are disclosed every trading day. In contrast, traditional mutual funds usually reveal their entire holdings just twice
a year.
ETFs may appeal to a broad range of investors. The major players in this market have traditionally been large institutional investors seeking to index core holdings or pursuing more aggressive market timing and sector rotation strategies. However, since smaller institutions and retail investors can trade in small lots, they can invest with essentially the same terms as larger investors.
Deborah Fuhr is vice president with Morgan Stanley & Co International, based in London. The table on page 39 is a comprehensive list of European ETFs available as of 19 October 2001 and is compiled from publically available information. Readers should note that the marketing, offer and sale of ETFs may be restricted in certain jurisdictions and should take advice accordingly