Exchange-traded funds (ETFs), investment vehicles that track a given index or benchmark, are perhaps one of the greatest financial innovations of recent years. Unlike conventional index funds, however, ETF units trade on stock exchanges at marketdetermined prices, thereby combining the advantages of mutual funds and common stocks.

Although the first European ETF came on the market only in 2000, assets under management of ETFs amounted to USD 143 billion as of late December 2008 (Fuhr 2009). In less than ten years, ETFs have become a serious alternative to other financial products, such as futures or index funds, that allow participation in broad market movements. In addition, ETFs are one of the few products that seem not to have been hit by the financial crisis. European mutual funds suffered outflows of USD 570 billion over the course of 2008; ETFs, by contrast, collected USD 74 billion (Fuhr 2009). And the ETF market is still growing: whereas the first ETFs attempted to replicate the performance of broad equity markets, newer products are venturing into more exotic markets and asset classes, such as emerging markets and alternative investments, real estate, infrastructure, private equity, and even hedge funds. As the market is maturing, being aware of the views and practices of ETF investors is essential. The aim of this survey is to contribute to this awareness by analysing the current uses and perceptions of ETFs in Europe. It is our hope that this survey will provide insight into how ETFs could further benefit investors. Finally, as it compares results with the results of past EDHEC ETF surveys, this survey sheds light on developments in the ETF market in the last few years.

In addition to their intrinsic appeal, ETFs provide a very convenient means of improving asset allocation in portfolio management. Indeed, this survey also illustrates how ETFs can be used in conjunction with core-satellite portfolio construction. This dynamic risk-budgeting technique, which has attracted growing investor interest in recent years, splits the portfolio into a core, which fully replicates the investor’s specifically designated benchmark, and a return-generating satellite (or satellites), which is allowed a higher tracking error. This survey demonstrates the main benefits of this asset allocation strategy: benefiting from the upside while keeping overall risk low.

The EDHEC European ETF survey 2009 was taken with an online questionnaire and e-mails to European professionals in the asset management industry. For a read on the possibly diverging views and opinions across the industry, this survey targeted institutional investors as well as asset management firms and private wealth managers. The questionnaire consists of sections covering the role played by ETFs in the survey respondents’ asset allocation decisions, practical aspects of ETF investments, as well as the applications of ETFs for portfolio construction. In addition, the questionnaire asks the participants to compare ETFs and other investment instruments that can be considered close substitutes: total return swaps, futures, and index funds. Finally, we invited survey respondents to express their views on future developments in the ETF market.

We find that European investors rely heavily on ETFs for asset allocation. In addition, satisfaction with standard equity ETFs, as high as 94%, is tremendous. However, the use of ETFs is largely limited to passive holdings of broad market indices. The wide range of ETFs for sub-segments and styles is not used to its full potential. Likewise, most practitioners do not benefit from the possibilities of trading options on ETFs, selling ETFs short, or lending them out. On the other hand, inverse ETFs are gaining popularity among ETF investors. Almost 30% of European ETF investors report using such products. ETFs are also being increasingly used for exposure to alternative asset classes: survey respondents report that ETFs account for 22% of their commodity investments. This is a considerable fraction, especially compared to the much more popular equity ETFs, which make up 36% of all the respondents’ equity investments. All the same, as they are not immune to the current financial and economic crisis, ETF products for the alternative investment universe are currently facing difficulties. Although they are gaining importance within their asset class, lower reported satisfaction may presage problems. Dissatisfaction with ETFs for hedge fund investment, for example, has already led to a decrease in the share of total hedge fund investment accounted for by ETFs.

ETFs and futures are the preferred indexing instruments. Most of all, ETFs are perceived to have an edge over other products in terms of liquidity, transparency, and cost. Respondents also appreciate the wide range of products and asset classes available with ETFs. So it would come as no surprise if ETFs and futures were to take market share from index funds and total return swaps.

The EDHEC European ETF Survey 2009 was sponsored by CASAM ETF.