If there was any doubt beforehand, the past 12 months have confirmed that interest in passive investment solutions is rising at an accelerated pace. Net inflows into European passive funds in 2016 – both index offerings and exchange-traded funds (ETFs) – totalled $83bn (£66bn), easily surpassing the $48bn netted by their active peers.
ETFs have been the main beneficiaries, gathering $51bn of new money to boost assets under management to $583bn, bringing them roughly level with the longer-established market of traditional index funds.
Unsurprisingly given this context, the outlook for the ETF industry is positive. Spurred on by an increasing acknowledgement of the long-term benefits of low-cost solutions, the take-up of ETFs – and passives in general – is expected to continue growing at a healthy rate.
However, key differences between the European ETF market and its more developed US cousin remain, particularly with regards to the products’ adoption by retail investors. Whereas in the US, retail investors and the financial advisers who serve them have fully embraced ETFs, in Europe growth has only scratched the surface. There are no firm statistics, but the accepted view in ETF industry circles is that around 50 per cent of the $2.5trn US ETF market is in the hands of retail clients. By contrast, in Europe retail adoption hovers at an estimated 10 to 15 per cent.
There are many reasons why the European ETF market has developed, and largely remains as, an institutional-client affair. Fund distribution channels, particularly outside the UK, remain dominated by commercial banks, which have traditionally favoured the placement of high-margin products. Also, the implementation of fee-based advisory models remains a pending subject for most, and where it is in place – as is the case in the UK – many of the large fund platforms serving financial advisers have been reluctant to undertake the necessary investment in technology that comes with the distribution of intra-day-traded funds such as ETFs.
Many in the ETF industry expect Mifid II to bring down the barriers that preclude ETF adoption by retail investors. Yet short of these pending regulatory changes, which will come into force in 2018 at the earliest, the status quo is being challenged by the growing popularity of online direct-to-consumer (D2C) robo-adviser platforms. Known as robo-advisers, these platforms are springing out everywhere to offer low-fee automated financial advisory services to cost-wary retail investors. The low-cost business model espoused by the robo-advisers means that some of the most popular invest exclusively in passive funds.
The appeal of robo-advisers has not gone unnoticed among the dominant forces of fund distribution in Europe. Many commercial banks are working on their own online D2C platforms. In some cases this has resulted in commercial agreements for the distribution of ETFs.
All the while, bowing to the pressure to adapt in face of growing demand, an increasing number of platforms serving financial advisers have plans to upgrade their technical infrastructure to allow for the inclusion of ETFs. Even ETF providers themselves ponder the potential benefits of setting up their own D2C platforms to reach the untapped wealth of retail clients.
