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The unstoppable rise of exchange-traded funds

WHEN one of Europe’s largest hedge funds, Marshall Wace, announced earlier this week that it would be launching an exchange-traded fund (ETF) to track its flagship strategy, it was further confirmation that ETFs are entering the mainstream on this side of the Atlantic.

In their standard form, ETFs passively track the performance of an underlying index and trade like a stock on an exchange. This makes them a highly transparent and liquid product, with low fees. The uncertain environment over the past two years has attracted investors to inherently diverse products, which are are perceived to be safer. These features have appealed to American retail investors, who are fed up with paying high commission fees to fund managers without any guarantee of performance. Today, around 70 per cent of the activity in the US ETF market comes from individual investors.

The product reached another milestone at the end of 2009 when investment vehicles traded on exchanges, mostly in the form of index-tracking funds, passed the $1 trillion mark globally. These assets under management are steadily growing in Europe. Deutsche Bank, which has just stepped up its research provision for exchange-traded products (ETPs), predicts that managed assets could grow by another 20 per cent globally, with a possibility that they could hit $1.4 trillion if bullish equity markets continue.

Deutsche Bank’s ETF strategist Christos Costandinides forecasts that European exchange-traded assets will approach the €200m mark this year, experiencing growth of 20-25 per cent. This builds on the 53 per cent growth in managed assets seen in 2009. Unlike the US, the European ETP space is dominated by the institutions, with individuals only contributing a third to overall activity in the region. But this is expected to change in the coming years. Like their American counterparts, European investors are starting to eschew independent financial advisers (IFAs) and expensive fund managers in light of their poor performance during the financial crisis. The relative simplicity of ETFs, and the ease with which they can be traded, has put ETFs on the map for private traders.

However, Costandinides says that retail traders in Europe are likely to stick to trading equity and fixed income ETFs while the more sophisticated institutions will be more inclined to get involved in the commodities and alternative asset ETPs. That said, a more diverse offering allows investors of all sizes to get involved in asset classes which might not have been possible with more traditional methods.

With the Financial Services Authority conducting its Retail Distribution Review, industry players are expecting a move towards products such as ETFs and away from traditional physical share dealing. Marshall Wace’s involvement is reflective of both the flexibility and potential of an asset class that is available to anybody, whether it is an institution or the man on the street.