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Exchange-Traded Funds - January 18, 2007

EDHEC European ETF Survey 2006

In a new survey, The EDHEC European ETF Survey 2006, the EDHEC Risk and Asset Management Research Centre has carried out an in-depth study on the use of ETFs (Exchange-Traded Funds) by European investors.

The results of the survey show that following rapid growth, ETFs are being widely used by European institutional investors, private bankers and asset managers.

The increasing popularity of ETFs is reflected in the responses of survey participants. More than half of the respondents are current or planned users of ETFs in equity investments (61%), and this is the case for more than a quarter of respondents (26%) for bond investments.

More remarkably, among those that use Equity ETFs, 92% were satisfied, which indicates an extremely high level of satisfaction. With 45% of responses, the most distinct reason for satisfaction was the reliability of the tracking error. 23% were satisfied with the good performance of ETFs, while 21% were pleased with the level of liquidity, and only 4% cited the reduced expenses of ETFs. Interestingly, half of the respondents who were not satisfied with Equity ETFs pointed to the poor level of liquidity of ETFs.

However, only a low percentage of respondents use ETFs for other asset classes than stocks. In particular bond ETFs, especially for certain maturity segments, are not widely used. This is surprising given that more efficient bond benchmarks (or core portfolios) can be constructed using an optimal allocation between subcategories and that alpha-generating strategies (or satellite portfolios) have been shown to be achievable using tactical allocation between such indices.

When respondents are asked about their satisfaction with bond ETFs, a considerably larger fraction expresses dissatisfaction when compared to the case of equity ETFs. Among the respondents who are users of government bond ETFs, 80% found ETFs were satisfactory. 35% named the reliability of the tracking error, 30% the reduction in expenses and 15% the good level of liquidity. But there remained 5% users who were dissatisfied with the poor level of liquidity of ETFs, while another 15% were not content for different reasons. The problems with treasury bond ETFs are apparently exacerbated when it comes to the case of corporate bonds. There are as many as 73% of respondents that do not use ETFs in this segment. Only 6% were trading corporate bond ETFs and 13% were planning to use them soon. In terms of satisfaction, low expense was the most popular feature of this investment instrument and was cited by 42% users. 17% of users claimed that they were satisfied with the reliability of the tracking error. However, the poor level of liquidity of corporate bond ETFs was cited by 17% as a reason for dissatisfaction.

Concerning the main future areas of development for ETFs, a clear majority of survey respondents quotes emerging markets (49%), commodities (36%), and, more broadly, alternative asset classes (41%). However, currently, only a small percentage of respondents are using such funds.

In the hedge fund universe, investable index products were not as popular in hedge fund investments as in the traditional field due to their relatively recent appearance. Only 7% of respondents were trading them. However there were 15% of respondents who were planning to use such instruments in the near future. Among the small group of users, only 27% were actually satisfied with the product they use. This can probably be explained by the fact that investable indices providers seek to promote track records that optimise the performance of their investment support “in sample”, a well known commercial practice that leads to favour backward-looking performance optimisation, instead of considering the robustness of future performance.

In the area of real estate investment, only 6% respondents were trading ETFs and 11% were planning to start trading such instruments soon. This is consistent with the fact that real estate ETFs are newly invented instruments. Half of users stated that real estate ETFs were satisfying because of the good level of liquidity they provided, the reliability of the tracking error and their good performance. Among the other half, liquidity was the main issue leading to dissatisfaction.

Although, like real estate exchange traded funds, commodity ETFs have only been introduced recently, they were more popular among respondents. 15% of respondents were trading commodity ETFs and another 20% showed interest in stepping in soon. The percentage of satisfied users was also greater than that of the alternative investment classes above. Among the 65% of satisfied users, 30% appreciated the good performance of commodity ETFs, 20% went for the reliability of the tracking error and another 15% declared benefits from the level of liquidity. But there remained 10% who cited the poor level of liquidity as a reason for dissatisfaction.

When comparing ETFs to alternative methods of indexed investing, European investment management professionals quite clearly favour ETFs over instruments such as futures, traditional index funds and total return swaps. Consequently, 55% of respondents think that the use of ETFs will increase in the near future, while only 34% have the same opinion about futures, and other instruments achieve even lower scores.

This survey was sponsored by iShares.