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A bright future for 10-year-old European ETFs

IT WAS 10 years ago this week that Merrill Lynch unveiled the first exchange-traded funds (ETFs) in Europe and listed them on the Frankfurt Stock Exchange. Britain was not far behind – iShares launched its first FTSE 100 ETF on the London Stock Exchange on 28 April 2000. A decade later, the European ETF industry now includes 896 products from 34 providers on 18 exchanges and has assets of $217.9bn. While this is not on the same scale as the more mature US market, which had assets of £821bn at the end of the first quarter of 2010, strong growth is predicted for the European market.

By the end of 2012, iShares’ parent BlackRock expects that assets will exceed $500bn based on the assumption of a compound annual growth rate of 30 per cent. This figure may well be a significant underestimate given that the compound growth rate was 90.5 per cent in Europe in 2009 and even the established US market experienced growth of 58.1 per cent. Globally, the industry grew by 56.3 per cent last year.

ETFs stood up well during the financial crisis and investors found that these products met their desire for greater transparency and liquidity as well as their concerns about counterparty risk.

Debbie Fuhr, BlackRock’s head of ETF research, expects that they will continue to be one of the preferred investment vehicles for low cost exposure to market returns across a number of asset classes.

She adds that the landscape will continue to evolve as more products and alternative asset class exposures become available to both retail and institutional investors. The expansion in the usage, breadth and product flexibility has already driven steady growth in the use of ETFs over the past decade. However, Fuhr forecasts that investors will continue to prefer core ETFs that passively track stock market indices despite providers’ enthusiasm for developing alternative products such as hedge fund ETFs and currency strategy ETFs. At the moment, the top 100 ETFs out of the 896 account for 69.5 per cent of assets under management. While we might see greater inflows into alternative ETFs, it is likely that the core passive products will continue to attract the most interest in the future.

The sheer size of the ETF market – global assets under management reached the $1 trillion milestone at the end of 2009 – makes it a difficult product for investors to ignore nowadays. BlackRock predicts that more hedge funds will be looking to create ETFs with their own funds as the underlying exposure, in an effort to broaden their distribution capabilities. While this will give more investors access to the asset class and the ability to do so in small sizes, Fuhr says that it will also make it more challenging for investors in the future to understand what they are investing in.

This is particularly relevant given that retail investors are expected to form a more significant share of the demand for European ETFs in the coming years. While retail investors account for between 40 and 50 per cent of ETF investors in the US, it is just 10 to 15 per cent on this side of the Atlantic. This is predicted to grow as the market matures and it will be given an extra boost by the Financial Services Authority’s (FSA) retail distribution review – industry compliance is due by the end of 2012.

Over the past 10 years, European ETFs have gone from nothing to a tried and tested means of trading the markets. The industry is forecast to continue growing at a strong rate and evolve into a more mature market like its 20-year-old US counterpart over the next decade.