All you need to know about European ETFs
ETFs stands for Exchange Traded Fund. At its core, ETFs share many features of passively managed mutual funds. However, as its name “Exchange Traded” stands, it provides the benefit of being traded on an exchange like common stocks.
The phenomenal growth of ETFs were propelled for a few reasons
- The broad range of ETFs offerings, with its superior transparency and eased market access, have offered institutional and retail investors a variety of investment choices by assets classes, geographic and sector exposures, investment styles, etc.
- The ongoing debate of passive vs. active, as a result of subdued performance in active investment with its unjustifiable high fees, has prompted the switch to low cost passive investment vehicle, like ETFs.
- ETFs proved to be useful building blocks for portfolio construction, for offering both broad and niche market exposure. Again, due to its ongoing product innovation, more and more active asset managers are looking for ETFs as a product wrapper to make the fund publically available for a range of investors.
Chart 1. Evolution of AuM for ETFs in Europe
How ETFs are regulated?
In Europe, most ETFs are incorporated as Investment Companies, which mostly domiciles in Ireland or Luxemburg, for various tax breaks benefits reasons.
ETFs will apply to list or trade on one or several stock exchanges in EEA countries before it becomes publicly tradable. To list and trade on an European exchange, ETFs need to meet listing requirement of the regional exchange, and satisfy the rules and procedures set out by the national regulators, an EEA Competent Authority.
For example to list and trade on London Stock Exchange, the funds have to meet
- The underlying vehicle for the ETF is an open-ended investment fund
- The fund is FCA authorised or recognised as UCITS
- The ETF is either settleable in CREST or Euroclear Bank, depending on the trading service utilised
ETFs already listed in other EEA countries can apply for FCA recognition and be admitted to trade on London Stock Exchange Main Market, without obtaining a listing in UK. This cross-listing provides a cost-effective approach to make ETFs accessible for local investors.
Europe vs. US ETFs
However, multi-listing creates segmentations and confusions in the European ETFs space.
There are total 3,326 fund registrations in European, which create 7760 unique listings cross 15 major European exchanges, according to database of ETFEurope.net
In comparison, there are around 2,282 US domiciled ETFs listed on three US exchanges, NYSE, Nasdaq, and BATS.
US and European ETFs are distinct in three major aspects
- US ETFs have a much greater adoption among retail investors and pensioners, who are more cost conscious and have greater risk appetite than European investors.
- US ETF has one streamlined trading and settlement process, while European ETFs settles as a fragmented network of central Securities Depositories at a member state level.
- US ETFs transacted at a ratio of 70:30 for on vs. off the exchange volume, whereas in Europe, the ratio is opposite. The large portion of European ETFs are transacted as bilateral or OTC trade, which suits large institutional investors who intent to execute large blocks without disclose volume or price. The low level best execution and reporting requirement in Europe hindered the liquidity and price discovery functions on exchange.
However, recent regulatory development in Europe has seen two key advancements.
- First, Mifid, which comes into effect from January 2018, introduced new and amended rules to enhance market transparency. However, it falls short of the long expected requirement around consolidated tape that aggregates and reports the volumes of ETFs traded into one place.
- The second is the introduction of Target2Securities, a single, centralized platform for securities settlement in euros across Europe. The aim is to reduce cross border settlement costs and contribute to the creation of a single financial market for Europe.
Chart 2. Number of ETFs listed on European Exchanges
Different Share Classes, Different Dividend and Currency treatment
In Europe, ETFs often comprise different shares classes with different right, features, terms and conditions, which further increased the complexity. The different shares class created as a result of —
Dividend policy
- Distribution
- Accumulating
Currency Hedging
- Unhedged
- Currency Hedged
Valuation Currency
ETF priced and traded in the different currency to its base currency. For example, on London Stock Exchange, ETFs can be listed and traded in GBP or GBX, EUR, USD, despite they have the same base currency, and belong to the same fund.
ETFs identifier system
Except searching for names, ETFs can be uniquely identified by
- ISIN: Allocated by the country of domicile. ISIN is unique to each ETF globally.
- SEDOL: a unique instrument identifier allocated by the exchange.
- TIDM: Tradable Instrument Display Mnemonic (TIDM), also called ticker, comprises the three or four character identifier specific to the exchange.
ETFs with multiple currency lines require unique TIDMs and SEDOL code, however, the ISIN of the multi-currency line will be identical. ETFs with different dividend policy or currency hedging features may or may not have the same ISIN, depending how the ETF are structured by the issuer. ISIN and ticker are commonly used by investment platforms to uniquely identify ETFs.
The benefit to be Exchange Listed
Because of ETFs are exchange listed, it trades exactly like shares, and share many similar characteristics that shares do while mutual funds don’t, for example, intra-day pricing, real-time volume calculation and the ability to trade anytime during the market open.
Active vs. Passive
ETFs is a passive investment, and the underlying allocation tracks the underlying index outlined in investment objectives. There are a small number of actively manged ETFs that have portfolio manager take active investment decisions to look for outperforming the market.
Chart 3. Indexing on the Rise — Passive U.S. equity funds could soon overtake their active peers
Index-tracking funds, including ETFs, tend to have lower cost than actively managed ETFs, as their goal is to solely replicate the performance of the index. Whether the higher fee charged by the active investment is justifiable to its performance is an ongoing passive vs. active debate. Before investing in any active funds, investor should thoroughly analyse investment strategy, portfolio manager’s styles and past performance. Similar to ETFs, investors should investigate underlying index styles, holdings, liquidity and cost, before making any investment decisions.
See our ResearchHub — What parameters to look at when invest in ETF.
What is an index?
An index is a collection of securities intended to represent a given market or market segment. Index are constructed and calculated to measure the performance against different geography, sector, styles or yields. Each index has its own methodology established by index providers, and index follows the rules set out by the methodology including
- Securities eligibility criteria: defines securities’ eligibility to be included in the investment universe, often measured against securities market cap or traded volume.
- Number of holdings: number of securities included in the index.
- Weightings: The percentage holdings of underlying securities, predominantly determined by market cap or equal weight regardless of securities’ sizes. There is an increasing number of smart beta ETFs whose underlying securities are weighted against income, quality or other factors.
- Rebalance frequency: monthly, quarterly, semi-annually that index reweighted to restore its pre-determined weightings.
ETFs by assets class:
The term ETFs is belong to a bigger umbrella group defined as ETP (Exchange Traded Products), which covers ETFs, ETCs (Exchange Traded Commodities or Currencies) and ETNs (Exchange Traded Notes). Depending on the type of the underlying securities, ETFs can be segregated into
- Equity ETFs: The underlying securities are stocks in developed and emerging market.
- Fixed Income ETFs: The underlying securities are government bond, corporate bonds, Inflation protected bonds, Agencies (including mortgage-back or assets-backed bonds), Convertibles, CDS or others.
- Commodity ETPs: The underlying securities are precious metals, energy, base metals or agricultures. Except gold, which is possibly held as physical gold bars, all other commodities are held via derivatives, e.g. futures or notes. Commodity ETPs are often structured as ETCs or ETNs.
- Currency ETPs: The underlying securities are individual currency pairs, (e.g. GBP/USD, JPY/EUR) or a basket of currencies (G10 currencies or commodity nation currencies). Currency ETPs are often structured as ETCs or ETNs.
- Structured ETPs: Structured ETPs often involves the leverage or inverse leverage, where the ETP return a multiplication of the underlying indices’ returns, in the same or opposite direction. Structured ETPs often sort the ETN structure.
- Alternative Assets Class: This include ETFs invest in every other assets class, Real Estate, Private Equity, Hedge Fund, and the volatility — VIX index.
- Multi-asset ETFs: ETFs holds more than one type of assets classes among equities, fixed income, or others.
- Thematic ETFs: it is a loosely defined section of Equity ETFs, where the overall investment theme is to identify identifying the structural trends that are disrupting the global economy and then looking at the companies that stand to benefit from the materialization of those trends. For example, notable thematic investments in ETFEurope.net incorporate 15 categories, including future mobility, healthcare breakthrough, etc.
Chart 4. European ETF distribution by asset classes.
ETFEurope.net provides access to +3,000 Europe domiciled ETFs listed on 15 Exchanges, forming a universe of 7,000 listings in different currencies and share classes. It offers free access to ETF key information, performance and fund flow comparison, enabling a quick and easy way to find the right investment in European ETFs.
