Exchange-Traded Funds in Europe

Adam Marszk,Ewa Lechman

• Éditeur: Academic Press
• Année: 2019
• ISBN:
  9780128136409
• Sujet: Economics
• Sous-sujet: Banks & Banking

Exchange-Traded Funds in Europe provides a single point of reference on a diverse set of regional ETF markets, illuminating the roles ETFs can play in risk mitigation and speculation. Combining empirical data with models and case studies, the authors use diffusion models and panel/country-specific regressions—as well as graphical and descriptive analyses— to show how ETFs are more than conventional, passive investments. With new insights on how ETFs can improve market efficiency and how investors can benefit when using them as investment tools, this book reveals the complexity of the world's second largest ETF market and the ways that ETFs are transforming it.

• Identifies benefits and threats that ETFs bring to European financial markets
• Combines empirical data with a full, in-depth analysis of the topic and the special characteristics of Europe
• Examines the diffusion patterns of innovative financial products, the role of ICT, and the consequent effects of ETFs on the underlying European stock markets

Chapter 1

Introduction

Abstract

This chapter describes the conceptual and theoretical background of Exchange-Traded Funds in Europe and presents the purposes of the book. It introduces the main issues and briefly outlines the contents of the consecutive chapters.

Keywords

Exchange-traded fund; investment fund; mutual fund; financial innovation; passive investing

We are living through a revolution in the way people invest. Never before have so many different investment products been available to investors at the click of a mouse (…).

Abner (2016)

Outline

• 1.1 Background 1
• 1.2 Aims and Scopes 3
• 1.3 Structure and Contents 4
• References 6

1.1 Background

That there are various forms of investment funds is undeniably a crucial characteristic of the contemporary financial system. By slightly modifying the definitions of a synonymous concept of “investment companies” provided by Abner (2016) and the Investment Company Institute (2017), and without dwelling into unnecessary details, they can be most broadly understood as financial institutions that gather financial resources from either retail and institutional investors and invest them in securities and other assets in order to reach a range of investment aims; investment funds are managed by investment professionals. Despite the relatively long history of some types of investment funds, their position has become significantly strong during the past few decades, boosted by various economic and social changes, and take place in the most advanced economies. Investment funds are a substantially heterogeneous class of financial institutions that, using the most general classification, covers (yet is not limited to) subcategories such as mutual funds, closed-end funds, exchange-traded funds (ETFs), private equity funds, and hedge funds. Moreover, investment funds have a broad range of investment aims, offering exposure to numerous asset classes in many sectors as well as countries and regions. Investment funds are also highly diversified in terms of their other attributes, including their legal form (vastly depending on the country-specific regulations or the structure of the local investment industry) and construction (with specific examples such as umbrella or master-feeder funds). During recent years the development of investment funds can be noticed globally in many dimensions including the two key perspectives: their assets and number. Substantial growth has also occurred in most cases on the country level.

In spite of the substantial and still increasing diversity of investment funds, most people (even in the group of the financial professionals) associate this category of financial institutions exclusively with the mutual funds that generally overshadow other types, such as closed-end funds or ETFs. Mutual funds are available all over the world in the majority of advanced and emerging economies; however, in the poorest countries their availability remains severely limited due to the underdevelopment of the local financial systems. These mutual funds are also the most diversified type of investment funds. The global assets of mutual funds as of the end of 2017 reached a record-high level of $45 trillion, out of which approximately 80% were managed by the United States and European funds, and most of the remaining by the Asia-Pacific institutions—estimations based on ETFGI (2018) and Investment Company Institute (2018)—which indicates the high level of the global market’s concentration.

Obviously, the focus on mutual funds can be explained by their domination on the global investment funds market. However, it should not be forgotten that this was not always the case. If we consider the United States—the world’s largest financial system (and also the biggest investment funds market) that is strongly linked to financial sectors in other countries through a broad array of interdependencies—we may clearly see that, in the early 20th century, closed-end funds were the dominant category and mutual funds had marginal importance mostly due to their later launch (Abner, 2016). However, starting from the stock market crash of 1929, over the next decades the position of closed-end funds sharply declined while, at the same time, mutual funds emerged as the leading institutions in the investment industry. There were some moments of increases in the popularity of closed-end funds yet these were rather short-lived (interestingly, one of the most recent episodes was interrupted by the rise of ETFs). This shows that the structure of the market for investment funds should not be regarded as definite as it has undergone changes, at times sudden and radical; the United States is not unique in this matter as investment fund markets have also evolved in other regions albeit that the exact changes have sometimes significantly differed. Moreover, it means that the leading position of the mutual funds may be threatened by the other categories of investment funds as well as some developments in the financial system. One of the main contestants is ETFs—investment funds that combine the attributes of various categories of financial institutions and products, and offer their users a range of previously unavailable investment possibilities.

The evolution of the investment funds market over the past several years should not be considered without taking into account the events in the global economy, in particular those that affected the global financial system, such as the 2008 financial crisis or the unparalleled spread of information and communication technologies (ICT) with their profound social and economic implications (Lechman, 2015). As emphasized in the opening citation from Abner (2016), technological revolution has in many ways influenced the investment industry, offering alternatives to the most frequently used bank deposits being accessible as probably never before and increasing the competition among providers of various investment services. More generally, ICT has reshaped all aspects of the financial system, starting from the services provided by banks, through to insurance for all dimensions of the financial markets (e.g., processing of transactions, access to information), among many others.

From a slightly different perspective, one of the key trends that shape the investment industries in many countries is the growing popularity of passive investing (indexing). The basic concept of passive investing is to track (replicate) the performance of the selected index (in other words, the performance of a specified market or a segment of it) rather than to try to outperform it. The reason for such strategy being, inter alia, the after-cost advantage in relation to active investing (Malkiel, 2016; Sharpe, 1991). Regardless of the possible objections to such an approach, its increasing popularity in the global investment industry is undeniable. It would be impossible without the introduction of the new category of investment funds that corresponds perfectly to the main assumption of passive investing—ETFs; however, the cause and effect are not so straightforward as, at the same time, the launch of the first ETFs appears to be an offspring of the heated discussion of the possible advantages of indexing.

The rapid expansion of ETFs is one of the key processes that have taken place in the investment industry (yet its pace differs substantially in various regions and countries; in some there are still no such investment funds). Within several years since their launch they have moved from a marginal product, almost unrecognized on a global scale, to a part of the mainstream financial industry. However, they have not lost their “innovative spirit.” ETFs can still be labeled as financial innovations as ETFs markets experience continuing innovational activity with the launch of new types of funds, giving more people access to the increasing group of assets and investment strategies. It may be stated that the launch of the first ETF can be regarded as one of the milestones in the global financial history. Such a designation can be explained not only by the broadening of the range of investments available to their users, but also by the emergence of the new segments of the financial system, such as robo-advising, that were impossible or unfeasible to offer before the advent of ETFs. It should, thus, not be surprising that launch of ETFs and development of the ETFs markets are described by Madhavan (2016, p. 3) as a “disruptive innovation to today’s asset management industry” and by Abner (2016, p. XVII) as “the most interesting products in the financial industry today.” It would, thus, not be an overstatement to regard them (with the usual caution) as a revolution in the financial industry.

The rising popularity of ETFs has resulted in the burgeoning academic literature devoted to this topic, with a vast number of interesting studies that address various aspects of this group of investment funds considered from various perspectives. Most previous studies focused on the key attributes of ETFs as tools for passive investing (e.g., their performance as funds tracking certain indexes) or the ways particular funds affect the related assets. There are obviously also many nonacademic publications that show various dimensions of ETFs, in many cases aimed at educating investors interested in this rather new part of the financial sector. Nevertheless, publications that cover the entire ETFs markets (in certain regions or countries) and the position of ETFs in the financial and economic system (including interdependencies between ETFs and capital markets) are rather rare. Moreover, the issue of the determinants of the development of ETFs markets (e.g., role of new technologies) remains, to large extent, unexplored. We attempt to fill these gaps, following, among others, the earlier stream of research that examined the factors behind the development of the mutual funds industry, with the seminal works of, for example, Klapper, Sulla, and Vittas (2004) or Khorana, Servaes, and Tufano (2005). Our discussion covering the main features of ETFs, their position in the investment industry, and the environment of ETFs markets draws heavily from the excellent books (the list is by no means exhaustive) by Ferri (2009), Gastineau (2010), Hill, Nadig, and Hougan (2015), Abner (2016), and Madhavan (2016).

It must be underlined that in our book we adopt a somewhat different focus and we do not present in detail the general issues that constitute a crucial part of the discussion concerning ETFs such as the advantages and disadvantages of passive investing or indexing (for more details see, for instance, Sharpe, 1991, 2013; Ferri, 2011; Ellis, 2015; Bogle, 2016; Malkiel, 2016; Schneider, 2017; Sialm & Sosner, 2018; for an excellent review of the current state of research on mutual funds see Diltz & Rakowski, 2018). However, we briefly discuss them within the outline of the main features of ETFs and the relationship of these investment funds with the other parts of the economic and financial system.

1.2 Aims and Scopes

Our book covers ETFs in European countries. We include in our analysis almost the entire group of these investment funds on the European exchanges (according to the criterion of primary listing; some yet rather insignificant exclusions stem from problematic issues from a methodological perspective). Despite the position of Europe as the world’s second-largest ETFs market (in terms of the aggregate assets in the region), most previous academic and nonacademic publications were highly US-centric—this should not be perceived as surprising due the longest history and largest size (in most possible dimensions) of the US ETFs market (the notable exceptions are, e.g., the papers published by the EDHEC-Risk Institute). However, we believe that for many reasons the European region is particularly interesting with regard to this part of the investment funds market and requires a separate and detailed presentation that accounts for some of its distinctive features, including the high heterogeneity of the European ETFs markets, the complicated legal and regulatory environment that experiences dynamic changes—with the crucial role of the law enacted within the European Union (EU)—and the high level of interconnectedness of the European financial systems (again, related to the cooperation within the EU). Another reason that to some extent distinguishes European ETFs markets (yet not all of them) from their counterparts in the other regions is the popularity of certain categories of funds that are absent or rarely available in the United States or Asia-Pacific region, the most notable example probably being derivatives-based (“synthetic”) funds.

The key aim of this book is to explore the issues associated with the development of the ETFs markets in Europe between 2004 and 2017. We discuss both theoretical and empirical aspects of these innovative funds, yet, to significantly contribute to the present state of knowledge, more attention is devoted to the presentation of empirical results with this respect. In other words, in what follows, we present an exhaustive empirical study regarding the issues that were almost untouched in previous publications in the field of ETFs.

In the flow of this research, we distinguish three major goals:

• • Explaining development patterns of the European ETFs markets (i.e., diffusion of ETFs) and providing predictions for their possible changes in the fut...