I feel like I have completed a whirlwind review of Exchange Traded Funds worldwide here at the Inside ETFs Conference Europe. I am here to satisfy my own interest in becoming more educated, as well as to prepare for speaking on panels at ETF conferences in Boca Raton, Singapore, and Amsterdam. Learning about Exchange Traded Vehicles (ETVs) will and should never stop as the products and the financial markets in which they are used will be evolving for many years to come.
The first ETF came about in the US in 1993 under the ticker SPY, also known as the “spyder.” The spyder enabled institutional investors to purchase the entire S&P 500. This allowed the investor access to market returns, while limiting specific company risk. This indexing concept through ETFs increased in popularity in 2000. Just seven short years later, investors could access virtually any worldwide asset class at a quarter of the expense of mutual funds.
It is these Exchange Traded Funds that have taken hold in America that are just now starting to take root here in Europe. I see a few roadblocks that may prevent ETFs from taking off here, though. A few of these obstacles were present in the US market during the rise of the ETFs, but Europe has some additional issues as well.
At Wiser Wealth Management, we are an independent wealth management firm with allegiance to no one to other than our clients. When we built our tool box of investment models and strategies, we only looked at products that maintained our investing philosophy of investing for the long term, keeping cost low, and always maintaining a diversified portfolio. We never chase returns, but rather manage overall portfolio risks adjusted for each client’s investment objective. We will not work for a commission, only a flat fee. This fee only approach to asset management binds our objective to the clients’ best interest. The final seal to the sitting on the same side as the client is our regulatory responsibility as a fiduciary; something our brokerage and banker counter parts refuse to accept. They are regulated in a way that allows them to sell products that may be suitable for the investor, but not necessarily in their best interest.
It is this independent fiduciary fee only platform that is lacking in Europe, thus most advisors there are pushing high cost and high advisor commission insurance-based products. Most of Europe’s ETFs are traded by institutions. In the United States, the Institutional/Retail breakdown is 50/50. One of my reasons for coming to this conference is to be an ambassador for fee only advisors in the US and encourage our colleagues across the pond to take up a platform that is more beneficial to their clients. My concept involves ETFs because ETFs do not pay a commission and are great tools in building portfolios. This does not mean that a commission broker will not use ETFs, it just means that they have an incentive to not too.
I was speaking with an Italian trader one evening. We discussed how fee only advice could start in Italy. He said that it was very difficult to start your own business in Italy and if it failed and the owner had to declare bankruptcy, he or she could go to prison. Maybe socialism has some drawbacks? So maybe in Italy advisors will not be jumping ship from the large banks and venturing out on their own, but there is always a possibility that they could make a policy change like that of the UK. In the UK, the government has passed a new directive to make their financial institutions look at all investing opportunities, not just their own financial products. This is an open door to more ETF usage in UK portfolios.
Another difference between the US and Europe is how ETFs are traded. This difference causes some liquidity issues in ETF trading. One reason for this is that ETFs can be traded on the local country exchange, OTC (Over the Counter), or directly from the issuer at NAV (Net Asset Value). Currently, the only reported trades are those done on the exchange. This multi-trading platform at times creates large bid/ask spreads. Trading volume would help close the bid/ask spreads. There was a lot of talk at the conference about reporting the ETF trade to a third party to help share information on pricing.
For the most part, ETFs in the US are simply purchasing an entire index, like one share of SPY buys you the entire S&P 500. Should the provider of the ETF ever fail, the ETF assets are not in question. The fund would simply be liquidated and you would receive your investment back at the current market value of the underlying securities. In Europe, some ETFs are not this straightforward, as there are two types. Physical ETFs are what we are using here in the States. Europe also has Synthetic ETFs, which are more complicated, and not necessarily straightforward for retail investors. If not used properly and with caution, these synthetic ETFs could get bad press and hurt the overall impression of Exchange Traded Funds. This is much like the inverse funds here in the United States.
Another challenge for ETF providers in Europe is that while each country shares a common currency, tax laws can be much different. Because of this, we see ETFs being purchased within each country’s own exchange. US ETFs are not purchased off our exchange as a European investor may have to pay US tax.
I will also note that the conference of several hundred delegates only had about 12 actual advisors. The others were institutional managers, traders, and lawyers. This tells me that ETFs have really not made it to the individual European investor. Next year, should I be invited back to the conference, I would expect and hope to see more retail advisors.
– Casey Smith is the Principal of Wiser Wealth Management and has spoken around the world about ETFs and passive index investing, including the recent Inside ETF Conference in Boca Raton, FL.