Investor desire for passive leading to ETF growth

Investors' preference to access passive strategies alongside active ones is prompting traditional active managers to develop their exchange-traded funds business in Europe.

Institutional investors are increasingly seeking low-cost strategies, driven by a low-rate environment and a heightened focus on fees. Given the growth of multiasset strategies in Europe that contain some passive elements in the last few years, money managers are looking to capitalize on the interest in passive.

"Large investors are requesting to have a full offering — index and active management — so they can access through one firm passive up to high-conviction expertise," said Isabelle Bourcier, head of quantitative and index management at BNP Paribas Asset Management in Paris. Last year, Ms. Bourcier moved to boost BNP Paribas AM's passive and ETF sales team with the addition of Katharina Anna Rost, who is sales manager for ETF and index solutions for Germany.

Sources said the passive landscape in Europe also is expanding, with quasi-active passive funds such as ETFs that enhance an index, for example, by screening for stocks with certain features. That's enabling new entrants to gain a foothold in this category.

In 2019, exchange-traded product assets in Europe increased 34.3% to $1.03 trillion from $767.7 billion, according to figures by ETFGI LLP, an independent research and consulting firm. Active ETFs made up 2% of those assets.

"Traditional active asset managers may struggle to compete profitably in the ETF market for core index products and have therefore been focusing on areas such as specialized ETFs and smart beta products," said Marina Cremonese, vice president, senior analyst at Moody's Investors Service in London.

The European market, with some 6% of all assets in ETFs compared with 24% in the U.S., according to Deutsche Bank Research, is developing more slowly than it did in the U.S. because of Europe's fragmented markets. With the passive share of total assets below 10% in most European countries, managers can still find an upside in Europe, "due to a much lower level of penetration of passive overall than forecasted five years ago," said Christian Zahn, Frankfurt-based partner and European asset management practice leader at McKinsey and Co.

Mr. Zahn thinks the passive growth on the institutional side has been below bullish expectations, excluding the fourth quarter dip in 2018, because some institutional investors are still satisfied with active products' performance.

Money managers see an opportunity in bolstering their ETF businesses, primarily through courting inflows into fixed-income ETFs, funds of ETFs and customized environmental, social and governance ETFs as investors seek to meet the requirements of European climate-change regulations.

Among the most recent managers to outline their plans to boost AUM through exchange-traded funds in Europe were predominantly active managers HSBC Global Asset Management and Goldman Sachs Asset Management. HSBC GAM, which increased its passive business to $49.3 billion at the end of September from $27.2 billion at the end of 2013, recently announced that it is planning a series of fixed-income and ESG ETFs in 2020. As of Jan. 17, the firm had $9.1 billion in ETF strategies, compared to $3.5 billion at the end of 2013.

As of Sept. 30 HSBC GAM managed $512 billion in total assets.

"Many clients continue to increase their allocation to passive investment products and we mirror this through the increased focus on our passive platform and by expanding the platform to cover those areas our clients are interested in," said Carmen Gonzalez-Calatayud, senior ETF product specialist at HSBC Global Asset Management in London.

"In the first half of 2020, we will launch a new family of ESG ETFs. Later in the year, we also plan to launch fixed-income ETFs, as well as a passive platform for precious metals," she added. The firm's current ETF offerings only cover equity.

Similarly, in October, Goldman Sachs Asset Management launched its European ETF business, subsequently launching three exchange-traded funds aimed at European clients: Goldman Sachs ActiveBeta U.S. Large Cap Equity UCITS ETF, Goldman Sachs Access China Government Bond UCITS ETF and the Goldman Sachs ActiveBeta Emerging Markets Equity UCITS ETF.

"We are betting on the ETF market and its growth," said Peter Thompson, head of ETFs for Europe, the Middle East and Africa.

"Increasingly, some of our clients started to ask us for our investment content in ETF format," he added. GSAM has 19 ETFs in the U.S., with more than $14 billion. GSAM had $1.86 trillion total as of Dec. 31.

Mr. Thompson noted investor demand for a supplemental offering "between pure passive if defined by market cap and pure active."

Ms. Bourcier added that BNP Paribas Asset Management's low-carbon ETFs have seen steady inflows since her arrival in 2016 from Ossiam, where she was head of business development.

BNP Paribas has more than doubled its assets in low-carbon ETFs since Oct. 31, 2018, to €800 million from €377 million, she said.

BNP Paribas' ETF AUM increased to €10.7 billion at the end of 2019 from €3.4 billion at the end of 2014.

Investor demand for ESG ETFs is focused on environmental considerations, as well as aligning portfolios with the European Union's taxonomy and themes such as a recycling-based economy, known as circular economy, she said.

Also, sources said the EU's Markets in Financial Instruments Directive II, which is requiring managers to disclose fee data to investors, has made investors more eager to include ETFs in their portfolios. MiFID II is increasing investors' knowledge about ETFs as their focus shifts to product and cost transparency, said Fannie Wurtz, head of Amundi ETF, indexing and smart beta.

Amundi's ETF business has nearly tripled to €55 billion as of Dec. 31 from €15 billion at the end of 2014. Amundi's AUM stood at €1.56 trillion as of Sept. 30.

Still, some sources said they see challenges in how traditional active managers can compete with the largest passive managers, such as BlackRock Inc., which are getting into ESG ETFs and active ETF strategies, too. On Jan. 14 BlackRock's global executive committee said in an open letter to clients the firm will be doubling its ESG ETFs, including sustainable versions of index products.

BlackRock is one of the dominant passive and ETF firms in the market, with $4.9 trillion in passive strategies including $2.59 trillion in institutional index strategies and $2.24 trillion in ETFs, allowing it to cut fees on its strategies more easily.

"Pure passive asset flows are concentrated on 80% of 10 top players in market," whose costs are declining at a much higher speed, McKinsey's Mr. Zahn noted.

"A total expense ratio of top passive players has declined in the last five years to 0.3% from 0.4%, while the rest of the managers have expenses of around 0.5%," he added.