Source: All replication methodologies introduce a concept of risk and return
In the second part of an interview, Peter Thompson (pictured), president of ETF provider Source, talks about the use of tracker funds as the underlying of structured products, the development of leverage/short and smart beta products, as well as the competitive landscape in the ETF market.
Are structured products a complement or a competitor of ETFs?
When looking at the UK market, I think you have to say both if you are honest. The retail market is dominated by structured products but we see more ETFs making inroads in the retail segment, which could be seen as a competitor product. At Source, we see them as complementary with places where they overlap and where investors can benefit. You can use either or both depending on your goals, the needs of your portfolio and the risk profile of the investor.
What’s your view on synthetic and leverage/short ETFs?
Our view has always been that this is an area of the market that is less well understood, and there have been questions raised around the suitability of these products. It is not an area we have been involved to date and we don’t see that changing. We are focused on the standard ETF wrapper to deploy our strategies around smart beta and active investing.
Why has smart beta become so popular in such a short period of time?
We have been talking to investors over the last five years and we see that in the institutional space there is appetite for using passive and actively managed ETFs along with increased interest in smart beta. Our plans is to expand the availability of these products in the retail segment. We believe there is a great deal of room for innovation in the passive space around index methodologies, alternative weighting methodology and other areas of innovation and a good example of this is our recently announced collaboration with Research Affiliates. We are an open-architecture independent firm and we are not beholden to a corporate or subject to a house view. We are not subject to a certain history or investment approach and we have the flexibility to go where our investors want us to go.
What is the unique selling point of ETFs?
The USP is a combination of simplicity and transparency and can suit the needs of a large or a small investor. Those are the real drivers of the success of this wrapper versus more traditional mutual funds, futures, etc. We think those two elements are behind the success of ETFs in the US market and we think this can be replicated in Europe as growth rates suggest this market has not reached its maturity yet. We expect the market to grow between 20% and 30% per year in the near term.
Will equities continue to drive sales in the short term? Is there demand for other asset classes?
Equities remain the core asset for most investment products. ETFs started tracking equity underlyings but they can also offer exposure to other asset classes. The appetite for smart or strategic beta is a spectrum between pure active and indexed. There is real appetite for innovation and the next generation of beta, and we believe ETFs can also add value in this segment. We listen to our investors and consider the best way to deliver new investment content either via an index or with one of our partners. The power of ETFs, which explains why they have been so successful, is their simplicity, transparency, specificity and liquidity. ETFs deliver what they advertise and you can do that at a simple beta level by replicating the performance of a major benchmark (S&P 500, Eurostoxx 50) but you can also develop ETFs with a greater focus such as the Stoxx Exporters ETF.
Are ETFs safer from a credit risk perspective than structured products?
All replication methodologies introduce a concept of risk and return, and physical and synthetic ETFs are no exception. Whether the risk manifests itself through a stock lending transaction in physical replication or a swap in synthetic replication it is still risk. What we believe is that critical to this process are two principles: first, risk minimisation and second, transparency. By prioritising this in all of our funds we allow investors to fully understand, track and evaluate risk every day in real time.
As it relates to securities lending, we believe that the same principles apply and that investors should be able to have full transparency into which securities are in the lending program, the percentage of securities in the lending program, the share of revenue from the lending program that is returned to the fund, and what specific collateral is received against the loan. This information should be available to investors on a daily basis.
How do you see the competitive landscape in the ETF market evolving?
In order to understand the added competitiveness in the market, you only have to look at the number and names of firms entering this market over the last 10 years. From the big to the small across the spectrum… banks, asset managers, you name it. I think the market is offering a lot of opportunities and this will attract new players that will help develop the market further by offering new content, and new choice. Also, ETFs originally catered for institutional investors but we have seen a significant growth in the retail segment, and this is also providing new avenues for growth.
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