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Reining In iShares

Written by Paul Amery

  
November 07, 2012 15:17 (CET)

Measured by market share, BlackRock’s iShares brand has a smaller piece of the pie in European ETFs (41 percent) than in the US ETF market (where it has 44 percent).

But iShares’ competitive position is much stronger in Europe. In the US the firm’s two largest rivals, SPDR and Vanguard, have a 20 percent share each.

Vanguard, in particular, poses a major threat to BlackRock, with the Pennsylvania-based mutual’s ETFs outselling those of iShares both last year and in 2012 to date. Vanguard has gained over $80 billion in cash inflows to its ETF range since the end of 2010, compared with $68 billion for iShares and $35 billion for SPDR.

But in Europe, iShares has almost monopolised new cash flows to ETFs for the last two years, with its two closest rivals, db x-trackers and Lyxor, suffering. iShares took in four-fifths of the $22 billion inflows to ETFs during 2011 and has gained two-thirds of the $20 billion invested into European ETFs so far this year. By contrast, Lyxor has lost $9 billion in assets over the 22-month period and db x-trackers has seen $0.5 billion in outflows.

Deutsche Bank’s ETF arm now has a 14 percent market share in Europe, followed by Lyxor with 12 percent. Credit Suisse, the next largest provider, has a 5.5 percent share.

Competition for iShares in new European ETF business has been coming from providers who are second-tier by market share—Amundi, Source and SPDR. The largest of these issuers, Amundi, is less than a tenth the size of iShares by assets and has around half the number of ETFs.

Lyxor’s and db x-trackers’ waning competitive positions are a direct consequence of the intense debate over ETF risks that began early last year. Rightly or wrongly, this debate was framed by many (including by BlackRock) as being about the derivatives-based (synthetic) ETFs issued by investment banks.

Although there’s arguably been a greater focus in the last year than before on some of the risks associated with the physical replication model that iShares uses for most of its funds (such as when securities lending is involved), this hasn’t helped the bank-owned ETF platforms.

The increasing regulatory pressure on investment banks’ balance sheets, combined with market pressure to place higher-quality (and therefore more expensive) collateral into synthetic ETF ranges and a desire at the management level to shed non-core operations have all hit bank-owned ETF businesses.

As a result, we’ve seen banks moving their ETF ranges into affiliated asset management entities or offering them for sale.  New product launches have slowed or stopped completely. Now, belatedly, and in what feels rather like an admission of defeat, Lyxor and db x-trackers have announced that they will be issuing physically replicated ETFs, having clung to and defended the synthetic model for years.

In the end, all of the top three European ETF issuers will therefore end up with a mixture of physically replicated and derivatives-based ETFs (iShares started selling synthetic funds in 2010), but iShares will have gained a huge leap in its competitive position in the interim.

So what, if anything, might topple BlackRock from its position of ETF market dominance in Europe?

iShares’ two main US-based rivals, SPDR and Vanguard, are both active in European ETFs, but have a huge amount of catching up to do. Both are sticking to the physical replication model, but the fragmentation of Europe’s markets means that it will be harder work for Vanguard to break into new countries.

As a result, it will almost certainly take longer for Vanguard to gain market share from iShares in Europe than in the US, where Vanguard has made rapid gains in the ETF market after a late start. SPDR, which has done better in Europe this year, remains a dark horse. The battle between these US-owned firms will be an interesting one to follow.

I can see two other ways in which iShares might slip up in Europe. First, if the firm’s reputation were to suffer due to one of its products’ performance. And second, if global regulators decide to turn their focus away from banks and onto asset managers.

Forcing asset managers to hold more capital against the funds they operate would force the same kind of reassessment of business models as has been taking place at investment banks during the last couple of years. It’s a long shot, but it could happen.

 

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