Reaching beyond the institutional

FT Mandate, January 2005, Gerry O’Kane

As a result of education and publicity Deutsche Börse finds that German retail interest in exchange traded funds is growing strongly.

Continued good news from the exchange traded fund (ETF) market over the past 12 months must have had shareholders in Deutsche Börse rubbing their hands in glee. Yet again its XTF segment, created especially for exchange traded funds, dominated the European market and for once in the financial industry, left the London Stock Exchange coming well back in the race.

Figures for accumulated turnover market share for September 2004 saw Deutsche Börse win 52.62 per cent of European market. London limped in with just under 10 per cent, while Euronext, with the three trading centres of Amsterdam, Paris and Brussels managed second place with just under 21 per cent. ETFs are traded in 11 European exchanges.

“We’re pleased with the performance the XTF has shown,” confirms Rainer Riess, Managing Director Stock Market Business Development, at Deutsche Börse.

The exchange became the first in Europe to offer trading in ETFs in April 2000, although their use was already commonplace in the US. Deutsche Börse’s new segment, the XTF, initially only comprised two ETFs: the Dow Jones STOXX 50 and Dow Jones EURO STOXX 50 index, currently among the most popular of the ETF investments in Europe.

“It has been positive news since our launch, with monthly average trading volumes increasing by more than 100 per cent on an annual basis, from €156m in 2000 to €2.68bn this year,” explains Mr Riess. The company’s ETF assets under management grew by an even steeper annual rate of nearly 140 per cent from €438m at the end of 2000 to €14.2bn at the end of October 2004.

There is little doubt that business is good across the ETF industry. Even December saw the XTF announce the launch of another new exchange traded fund, the eb.rexx Jumbo Pfandbriefe issued by Indexchange Investment AG. Its base index is based on the eb.rexx Jumbo Pfandbriefe selection and calculated by Deutsche Börse from the continually generated prices of the 25 most liquid fixed-income instruments in the Jumbo Pfandbriefe segment of the electronic fixed-income trading platform Eurex Bonds.

According to Mr Riess, however, the growth in the European market in general, and on the XTF specifically, was not simply a function of new products. “Although several new ETFs were launched over the recent months, we’d estimate the largest part of the growth in assets under management to be the result of an increased interest in ETFs from the investment industry.”

Investor awareness

“Educating potential investors on the advantages of ETFs is one of our major goals,” says Mr Riess pointing out that increasing investor awareness has been another success for the exchange over the past year, but also accepting that it has not been a solo project. The six issuers that Deutsche Börse quotes, Credit Suisse Asset Management, Indexchange, iShares, Lyxor International Asset Management, UBS Exchange Traded Funds and Unico Asset Management have all been busy in investor classrooms as well.

“In terms of product launches, 2004 has been a year where ETF issuers have primarily concentrated on increasing their investor base by highlighting the strengths and advantages of their existing ETF product offering,” accepts Mr Riess.

But precisely who is benefiting most from learning more about the product range and its use, is open to debate. From the exchange’s perspective nearly all the big buyers of investment products have been shopping on the XTF.

“Insurance companies and asset management houses probably account for the major stake of the trading,” identifies Mr Riess. But he has noticed new developments that have helped boost trade.

“In addition to the traditional players, small proprietary trading firms and hedge funds have discovered ETFs and are using them as a complementary trading tool for the implementation of trading and arbitrage strategies, thus providing liquidity to the market and helping to increase market efficiency,” says Mr Riess.

But for once the story is not limited to the institutional players. Figures indicate that, at least in Germany, retail interest is growing strongly. Deutsche Börse finds the most accurate way to measure this is by transaction size below €25,000. These transactions have grown to nearly 40 per cent of ETF transactions on the Xetra as a result again, believes Mr Riess, of the effort of the industry to boost education and publicity.

“Considering the lack of incentives available to traditional distribution channels such as banks and independent financial advisers, the success of ETFs among retail investors is quite remarkable and something to be positive about for the future too,” he adds.

Other trends have been identified by Mr Riess that will help support the market, independent of the excitement of an inexpensive new product.

“Equity ETFs have grown to one of the most successful new investment vehicles and we expect this to remain so, given the ongoing trend towards passive investment,” he explains. But he also points out that while both trading volumes and assets under management tended to concentrate on ETFs tracking blue-chip indices, because of their extraordinarily high liquidity, the advent of fixed-income ETFs on the exchange in February 2003, brought even more customers to the table.

“The advantages of equity ETFs were transported to a whole new asset class, providing investors with the opportunity to gain exposure to a diversified basket of fixed-income instruments in a convenient and cost-effective way and we’d expect to see them growing in importance to the market soon, as well,” explains Mr Riess.

The one limitation to the ETF is regulatory. Part of trying to boost their accessibility to investors is that quoted vehicles had to be registered for public distribution which also limits the range to European products but allows them to be also sold in other European markets. In order to provide investors with exposure to non-European regions, most issuers have chosen to offer European ETFs tracking global and international indices in their respective home market currency.

Considerable liquidity

One of the oft-quoted criticisms of ETFs has been their lack of liquidity, which prevents some institutional investors from viewing them as a valuable asset class. While the traditional answer is that these products are as liquid as their underlying assets, a look at Deutsche Börse figures would tend to show that their liquidity can be even higher than expected. “Since 2000, ETFs have actually become the most liquid instrument group traded on our electronic trading platform Xetra, and this has helped us in our effort to market ETFs to a broader range of customers,” argues Mr Riess.

Even for the latest product offering, the eb.rexx Jumbo Pfandbriefe, news of liquidity was startling. The Eurex Bonds trading platform saw a new high achieved in the trading of Jumbo Pfandbriefe in the first week of December with average daily turnover of €80m, good news for the argument that an ETF reflects the underlying product liquidity. Add to that an annual management fee of 0.09 per cent and one can understand why such products have attracted increasing numbers of investors.

Indeed, liquidity in ETFs – as measured by the exchange’s XLM (Xetra Liquidity Measure) tool – was at record levels in November 2004 and points to a healthy future. “Although the number of ETF users is continuously growing, there is certainly room for further expansion, particularly once new investors become aware of the advantages ETFs have to offer, including this excellent liquidity,” concludes Mr Riess.

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