The market: M&A activity in European ETFs
The European ETF industry is still relatively youthful compared with its US counterpart, but already there have been significant mergers and acquisitions.
In the past 18 months, WisdomTree has taken over ETF Securities’ European arm, Invesco has snapped up Source – as well as Guggenheim Partners’ smart beta range – and Legal & General Investment Management (LGIM) has acquired Canvas.
The rush to combine with other providers suggests that the sector will become dominated by a small number of very large players.
So what is driving the move towards consolidation – and does it mean the end of new entrants?
The consensus seems to be that the market is very much open to new providers.
Howie Li, head of ETFs at LGIM, says: “There will be new entrants even if there are a reducing number of established independent ETF firms available for acquisitions. As our industry evolves, asset managers with traditional mutual fund structures are likely to need to build ETF expertise organically, rather than through mergers and acquisitions.”
And he adds that while scale is important, there are opportunities for smaller providers in more focused investment areas.
Fannie Wurtz, managing director at Amundi ETF, indexing & smart beta, says: “The European ETF market is very dynamic and benefits from a steady pace of growth and increasing demand. Strong drivers, such as new regulations, new distribution channels, a challenging macroeconomic environment, and a ‘retailisation’ of the space also support the expansion of the ETF market in Europe. This ends up attracting new entrants, with consolidation moves from players aiming to achieve economies of scale.”
Nick King, head of ETFs, Fidelity International, says that regulatory change – which is driving a focus on cost and transparency – is favouring disintermediated distribution channels.
“In this context, the ETF wrapper is an extremely convenient and efficient vehicle for delivering investment capabilities and I would expect more managers to take advantage of this,” he says. “There are a number of developments which could support the creation of efficient active ETF structures, and I believe that this could be a driver for some new entrants.”
Openings for innovators
Other managers see potential for new providers if they offer innovation.
Frank Spiteri, head of European distribution, -WisdomTree, says: “Consolidation may very well mean the end for new entrants launching vanilla beta products, but there is still room for new entrants launching differentiated strategies. That may be in alternative asset classes, or it could be smart beta or active investment strategies using the ETF vehicle.”
He believes the plain vanilla beta market is saturated.
“Will we see a new provider come to the market with a plain vanilla offering and compete with the current behemoth funds?” he asks. “No, we highly doubt that. Their competition is too big, too well-established and very low cost. There’s no way a new entrant could compete here or make a viable business in this space.”
But he says that launches targeted at a particular market or market segment, challenging the big funds with a viable alternative, could see a new competitor emerge.
“Even then those funds need to be sold; they won’t be bought off-the-shelf like the larger plain vanilla funds that have the scale,” he cautions. “It will therefore be difficult to get to double-digit billions in those products. Distribution is key for this type of approach.”
He sees potential for success where new entrants deliver thematic funds: “We’ve seen particular themes like robotics and cyber security attract billions in investment.”
“Investors are welcoming of new entrants to increase competition and broaden the variety of exposures available,” agrees Christine Cantrell, UK sales director for ETFs at BMO Global Asset Management.
Cantrell says the company is still the only provider to offer global corporate bonds segmented into multiple maturity bands – to help clients manage duration – and the first provider in Europe to offer covered call strategies in a UCITS ETF.
“Scale is important however,” she acknowledges, “And since ETFs are typically managed in a passive or systematic approach, the economies of scale can be harnessed and leveraged through a global ETF business. Processes can be shared across the Atlantic and the magnitude of assets managed in ETFs globally facilitate strong relationships.”
Views vary as to whether MiFID II has had an impact on consolidation within the ETF sector.
Spiteri says: “MiFID certainly provides a regulatory framework that should favour an increasing use of exchange-traded products, but more than anything else it is because the narrative has moved on from active versus passive.”
He continues: “Most investors are now considering how to implement various investment strategies – beta, smart beta and active strategies – and asset managers are reacting to that. They recognise that their investment propositions need to evolve to meet client demand, and ETFs are a big part of this changing landscape.”
Not a magic formula
But he adds that the ETF wrapper should only be considered when this gives a clear advantage to being exchange-traded, providing intra day liquidity: “The vehicle isn’t a magic formula in itself.”
Li says that MiFID is not a particular factor behind consolidation – rather it is the increasing realisation that ETFs are flexible structures that can be used to create products across different investment capabilities.
“Scale is important … And since ETFs are typically managed in a passive or systematic approach, the economies of scale can be harnessed and leveraged through a global ETF business”
“They represent an evolution of the traditional mutual fund model, especially as our industry prepares for increased digitalisation,” he says. “They are mutual funds with extra features such as real time price transparency, and that fits well with the digital model.”
Cantrell says: “I believe consolidation is mainly due to greater adoption and acceptance of ETFs as mainstream investment vehicles by wealth managers, and more recently, retail investors and pension funds. It is clear that the most popular multi-asset strategies in recent years are those that have promised to keep costs low, whether that’s achieved using a blend of active and passive strategies, or exclusively ETFs.”
But will consolidation bring about a slimming of the medium-sized ETF provider market?
Some observers see it already taking place, with a sizeable gap between the largest ETF players and smaller ones.
And Spiteri sees the trend continuing.
“What is clear is that across the asset management space there is demand for ETF capability, whether that’s product development or distribution,” he says. “This demand won’t be going away any time soon, therefore acquisitions are likely to continue where possible.”
But, having worked closely on the sale of ETF Securities to multiple asset managers, he says: “It is clear that acquiring an ETF business and slotting it into your current business model isn’t straightforward. And there are not many acquisition targets left.”
Meanwhile, the 2008 financial crisis has prompted moves towards consolidation within the index market.
“We have seen a number of banks, many in Europe, exiting the business of administering their own proprietary indexes,” says Richard Redding, CEO of the US-based Index Industry Association, the lobby group for index providers. “After the financial crisis and the subsequent European regulations, these banks questioned if being in the index provision business was a core function and use of capital.”
“What is clear is that across the asset management space there is demand for ETF capability, whether that’s product development or distribution. This demand won’t be going away any time soon”
He says the ETF distribution channel is very compelling for many asset managers who rely on their own proprietary investment approach. As they need to put those processes into rules-based approaches, some have self-indexed.
“However, as asset managers start to realise the full impact of the European Benchmarks Regulation, many self-indexers may find it complicated and expensive to comply,” he says. “The self-indexers are likely to partner with index providers who have the operational and compliance infrastructure in place.”
The fees debate
Meanwhile, in the wider ETF sector, the effect on fees resulting from the drive towards more mega-sized players is a subject of keen debate.
Greater size should in theory bring about economies of scale; conversely, less competition between providers could mean less pressure on fees.
But the majority opinion is that consolidation does not have to be bad news for the investor.
“More competition can certainly create pressure on fees but it is also driving new entrants to find ways to differentiate, ensuring that the industry evolves and offering greater choice to investors,” says King.
Spiteri agrees on the importance of differentiation.
“Cost is only an issue in the absence of value,” he observes. “If your fund is different and delivers performance, it’s easier to justify a higher fee.”
By contrast, he says, when a product is the same as everyone else’s, the only way the provider can really differentiate is through size and cost: “We’ve seen examples lately where providers have been unable to compete with the large established plain vanilla funds, and have drastically cut fees to low single digits in a bid to compete.”
But he says competition has also entailed a compression in fees.
“Again, this is good for the investor,” he says. “This fee compression isn’t limited to passives. We are seeing fee compression across the active market as well, and active managers are being made to justify their fees in the context of fund performance. That is a good thing.”
However, Cantrell is more cautious about the benefits of consolidation.
“Some mergers and acquisitions can be in the interests of investors, where small businesses can benefit from greater efficiencies and a wider audience familiar with the brand,” she says. “But I’d argue that competition is ultimately in the best interests of the end investor.”
She says that BMO Global Asset Management is very conscious of its ETF pricing strategy because it has been shown that net new assets in ETFs are skewed towards ETFs with comparatively low ongoing charges figures.
“While we provide unique strategies that have not been offered in ETF format until now, we ensure we are not only competitive within the ETF market, but also more broadly against mutual funds which have been the only way to access strategies such as those involving covered calls,” she says.
And Caroline Baron, head of EMEA sales, Franklin Templeton, cautions against an over-emphasis on costs.
She points out that the continuing low rate environment has highlighted the importance of fees, “but clients have to focus on what they are looking to achieve, as the cheapest solution is not always the one that meets their requirements and what works for one client may not work for the next”.
“Clients have to focus on what they are looking to achieve, as the cheapest solution is not always the one that meets their requirements”
For example, she says, one client may be looking for a long-term holding and wants to consider only a physical ETF with an Irish domicile; another may be looking for a short-term tactical trade and has the ability to invest in derivatives.
“Price will not be what these investors look for primarily – it will be in the mix at some stage, but will not lead the decision-making process,” says Baron. “That’s very important, as we’ve seen many sophisticated investors selecting only by price and ending up with the wrong product.”
And she considers new entrants to the market to be necessary to ensure that clients have choice: “Clients will also benefit from different thought processes and the ability to navigate between different providers, because having all your eggs in the same basket is never a good idea.”