ETP fixed income trend points to dichotomy

Exchange-traded products have seen strong inflows at opposite ends of the debt spectrum. Also, BlackRock addresses accusations that ETPs are not as cheap as billed.
ETP fixed income trend points to dichotomy

Growth in exchange-traded products (ETP) this year has been led by fixed income, although quirkily most money has been drawn into opposite ends of the risk spectrum.

Meanwhile, Dan Morillo, global head of investment research for iShares, defends against an accusation that ETPs are not as cheap as providers would have people believe.

Data from BlackRock, whose exchange-traded funds unit iShares is the world’s largest with $628 billion in AUM, finds that $85.3 billion in net new assets poured into ETPs globally this year to end-May, an 18% year-on-year increase.

Of this, $36.5 billion (43%) has gone into fixed income, two-and-a-half-times more than the corresponding period last year. This was followed by developed market equity ETPs (+$27.8 billion) and emerging market equity (+$16.1 billion).

What is striking is the nature of the inflow into fixed income. It’s led by investment grade credit at $12.3 billion, followed by high-yield at $7.7 billion. If you look at May in isolation, government debt ETPs attracted $5.5 billion, while high-yield saw $1.3 billion in outflows.

It is what Morillo describes as a barbell. “A lot of flows [into fixed income ETPs] have been driven by flows in and out of safe-haven assets, particularly US Treasuries as well as marquee assets in Japan, Germany and the UK,” he says.

“This is interesting because it has been occurring simultaneously with a hunt for yield. So you get a dichotomy where on the one hand flows are driven by a flight to safety whenever there is any noise, particularly in Europe, but then there is this trend of looking for yield, so we have seen significant flows into the high-yield ETP space.”

Of course, the majority of this activity will be coming out of the US, which accounts for a dominant 71.6% of the global ETP market, according to data from Morningstar.

By Morningstar numbers, there have been global inflows of $73.8 billion into ETPs this year to end-May, of which the US accounted for 84%, compared with just 7% for Asia.

Morillo suggests there has been strong interest in emerging market fixed income ETP product as well as emerging market equities, of which Asia makes up a part.

Among Asian investors he sees interest in locally listed fixed income ETPs and higher yielding products in general. “Our general sense is the ETP market in Asia is larger in the institutional space than in retail, but we do see the retail space growing,” he says.

He describes the distribution mechanisms in Asia as more heterogeneous than in other regions, and points to the different regulatory structures and education levels as challenges to growth.

“Our sense is that transition in the intermediary space goes hand-in-hand with how fast the industry attempts to move to be transparent and potentially provide more of a fiduciary standard,” he adds.

By Morningstar figures, iShares had a less-than-stellar three months to the end of May, with $2.4 billion in outflows from its ETFs globally. That contrasts with Vanguard, which attracted $7.7 billion over the same period.

Add the first two months of the year, however, and iShares saw $15.8 billion in ETF inflows to end-May in 2012 – lagging Vanguard at $24.5 billion. And the latest BlackRock figures suggest iShares has closed the gap with $24.2 billion in inflows to date in 2012, next to $28.6 billion for Vanguard.

Recent articles in the media have attributed Vanguard’s strong inflows to its low-cost fee structure.

One regional private banker in product selection based in Hong Kong recently told AsianInvestor that ETFs are not as cheap as providers would have people believe. He cites the expense ratio for one of the region’s most popular ETFs, iShares China A50, as 1.39%. “That’s not cheap, especially when you add in private bank fees of 25-50 basis points,” he notes.

Asked about fees, Morillo notes that the globally weighted average fee by AUM across the board is massively lower than that for comparable mutual funds. He says fixed income fund products (including active and passive) in the US charge around 90 basis points, compared with 20s for ETPs.

Further, he argues there are additional features of ETFs that are important in an investor's due diligence when selecting ETFs.

He points to the breadth and depth of BlackRock’s ETP offering as important in terms of liquidity. "In addition there are considerations of tax, tracking error and transparency," he says.

"The total cost and total performance of an ETF investment is linked to all of these, and in a wide range of cases the direct fee is not the key or even the main consideration, particularly given the importance of tax and transaction cost for a wide range of investors."

He adds that many iShares products have higher lending shares than competitors, providing a revenue offset. “People tend to use our products slightly differently,” he adds.

“Pricing is something we always evaluate, and we price our products competitively. But we do not believe that the ETP space is anywhere near the time where these products are viewed simply as commodities and the only thing that matters is price.”

BlackRock’s iShares unit has a 39.6% share of the global ETF marketplace, followed by State Street with 18.5% and Vanguard with 12.5%, by Morningstar numbers. It has more than 500 listings globally, of which 49 are in Asia (27 locally domiciled ETFs and 22 cross-listed ETFs).

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