ETFs in Europe have had a tough year, with an onslaught of critical comment and difficult markets causing the industry's growth rate to come to a halt. But active managers are doing much worse.
As we reported earlier this week, citing the latest figures from Deutsche Bank, Europe's ETF market has seen a notable slowdown, following several years of rapid growth.
Barring a Santa Claus rally, assets in European ETFs may end the year slightly down from 2010 levels, the first absolute annual decline in the market's history. For the five years to end-2010, by contrast, they grew at a compound annual rate of 40%.
The halt in asset growth masks continuing inflows to European ETFs. Falling market values have counteracted net new cash flows of €17 billion, says Deutsche Bank's Christos Costandinides, measuring the state of play at the end of November. BlackRock, the ETF market leader, has been the overwhelming beneficiary, garnering over 60% of investor inflows, we calculated a few weeks ago.
It's hard, though, not to draw some connection between regulators' spring warnings about ETF risks, rising bank default risk, and the slowing in the ETF market's growth. Counterparty and collateral risks are on the rise and have clearly had some impact on the growth of the synthetic ETF business.
MF Global's failure and the disappearance of investors' money from supposedly safe client accounts have also drawn attention to the risks involved when assets are lent out under repurchase agreements. MF Global's losses apparently relate to the rehypothecation (re-pledging) of the collateral placed with the firm by customers.
UCITS, the regulations governing most European ETFs, do not allow the pledging of non-cash collateral taken under securities lending agreements. Here, for example, are the rules for securities lending and repo transactions currently applicable to UCITS domiciled in Ireland.
But that doesn't necessarily remove all risk. As one correspondent told me this week, "Even when UCITS do not repo their assets directly, it remains to be seen how many of them formally prohibit their depositary bank to use their assets for repo. My guess is that up to now only a small proportion do so. This is a particular concern if the asset manager and the depositary bank belong to the same financial group."
Investors would therefore be well advised to check the small print of their fund managers' custodial arrangements.
But if ETF issuers have had a difficult year, it's been even worse for those managing active funds.
The latest Lipper fund flow figures show how actively managed equity funds have started to haemorrhage cash again, after a better couple of years in 2009 and 2010. For the third year in five, active funds are seeing tens of billions in investor withdrawals.
Net Sales Of European Equity Mutual Funds (€ million)
Source: Lipper, a Thomson Reuters Company
Growing investor disillusionment with managed equity funds is unsurprising, given the multitude of recent studies showing that a high proportion of investor returns is eaten up by fees.
As David Norman, author of one of the studies, put it, "In the current low return environment costs take on an ever more important role in fund returns; high costs mean investors are effectively trying to walk up the down escalator – a sure-fire way to get nowhere fast."
Some active managers have responded this year, launching low-cost fund variants to counteract the competitive pressures being posed by index trackers such as ETFs.
But as another year in the markets draws to a close, competitive pressures in the asset management business are clearly intensifying. ETFs have been in the headlines in 2011, but it's the active fund providers who face a wholesale reevaluation of their business models.