ETFs

ETFs in 2020

A comprehensive paper published by PwC last month entitled ‘ETFs in 2020’ paints a very detailed picture of how the Exchange Traded Fund business is likely to evolve globally over the next five years. According to the analysis, the market will double to $5tn by 2020, and its impact has the potential will be felt much more widely within our industry than previously imagined.

A few takeaways from the report we found particularly interesting:

  • Despite fragile economic growth in developed markets, the global AM industry is predicted to grow at a healthy pace. Having doubled over the past decade (to $70tr), PwC predicts professionally managed financial investments will grow by 6% per year , due to both asset inflows and value appreciation. The US & Europe will dominate asset flows in absolute terms, but the highest rates of growth are likely to come from developing markets. Passive funds currently account for around 35 per cent of all mutual fund assets in the US.

  • New types of indexing (also referred to as ‘smart beta’) are perhaps the most important area of innovation within theproduct class. As they continue to evolve, a growing number of investors are likely to opt for index weightings based on factors other than market capitalisation, which by itself can lead to overly concentrated exposure to certain markets, sectors, or securities. The size and scope of actively managed ETFs are also set to grow (there are currently 55 actively managed ETFs listed in the US with AUM of $9.6 billion).

  • The regulatory environment in the US and Europe is expected to have a significant impact on the evolution of ETFs. New regulations could spark further growth if they permit further product innovation or lower distribution barriers, but they could also dampen demand, particularly if new tax rules make ETFs less attractive or convenient. For instance, MiFID II could be a game changer in Europe, where the adoption of ETFs by retail investors significantly lags behind the US.

  • Firms offering ETF products to investors will need to consider rapid changes to the way asset management services are created and consumed, with the most dramatic changes enabled by technology.

If the predictions do come true, they will no doubt have an impact on a future shareholder register structure and consequently on corporate IR strategy.

A few questions for companies to consider:

  • Do I monitor my shareholder register on a fund level, for the activity of the largest three ETF fund providers: Vanguard, Blackrock (iShares), and State Street (SPDRs)?

  • Am I familiar with which are the largest and most active ETFs in my asset class? I am aware of key trends and drivers of their growth?

  • Do I know which indices is my security a constituent of?

  • Am I staying on top of developments in the active ETF space?


Activist Investor’s influence on Passive Funds

The cover story from this week’s Economist caught our attention, particularly as it relates to a number of IR themes we have been observing closely. Academic literature* examining the recent track record of US activist investors concludes that despite their reputation and short term focus they are more often than not a force for good, at least in terms of driving greater operating performance and shareholder returns.

The article draws attention to a polarity in today’s average shareholder structure, one that is particularly evident in the US. On one side of the spectrum is ‘lazy money’ which comprises a growing number of computer-run index tracking funds, ETFs and mutual or pension funds, which generally prefer not to get too involved in radically altering the strategic direction of the companies they invest in. On the other are large funds which buy entire companies, often taking them private and actively dictating strategy.

Activist investors can fill a key corporate governance void by influencing passive funds and ‘lazy money’ to take an interest and support either the activist investor or management’s chosen course of action. The long-only funds holding the majority of the free float generally assume the role of ‘blocker’ or ‘enabler’ for activist campaigns so the more involved they are the better. This involvement looks set to increase as activist funds grow in popularity. In 2014, a fifth of flows into hedge funds went to activist investors, resulting in their AUM rising from $55bn to $120bn over a 5-year period.

The two largest providers of passive products, Blackrock and Vanguard, have already pledged to work more towards ‘long term interests’; this will inevitably include increased contact with company boards. Company management and IR teams may also make a more proactive effort to establish relationships with passive managers, something which was not really considered as recently as a few years ago.

The final angle of the debate centres around the potential for transferring the US-style activism model across the Atlantic, particularly given the arguably limited opportunities in the US (only 76 companies in the S&P 500 registered a poor 5-year Return on Equity and only 29 trade below their liquidation value). European investors will argue that they already have more say than their American counterparts on corporate governance issues such as renumeration and board appointments, and differences in culture as we move east mean that many activist fund demands are often settled discretely and diplomatically.

Long Term Effects of Hedge Fund Activism, Lucian A. BebchukWSJ