by Stephan Pouyat, Global Head of Capital Markets and Funds Services, Euroclear
Towards a unified distribution model in funds
Change does not always announce itself with a fanfare. It can creep up in a series of small steps. Taken together, those steps can amount to something transformative.
That, I believe, is what is happening now in the funds business.
Historically, there has been a clear divide between investment funds (for example mutual funds and alternative funds) and Exchange-Traded Funds (ETFs). That divide is being crossed more and more.
It is a response to several factors. A prime one is investor behaviour, and especially surging demand from institutions for Environmental, Social and Governance (ESG) investments. Another is the drive for global distribution on the part of the bigger asset managers.
The big investors want to access investments in the simplest, cheapest way possible – and be able to trade them in a liquid marketplace. In the funds area, that means ETFs not mutual funds.
The mutual funds market in Europe is largely retail-oriented. It relies on a primary distribution model which can be cumbersome and expensive. There is no real secondary market.
By contrast, the ETF market is the other way around. It is overwhelmingly institutional and 80% of the activity takes place in the secondary market (as the name implies, ETFs have the secondary market embedded in their make-up).
The events of recent months have demonstrated the over-arching importance of liquidity from the institutional investor standpoint. At a time when many of the underlying bond markets seized up, ETFs continued to trade – and in volume.
Institutions are now piling into ESG ETFs. Nearly half of the new ETFs launched in Europe in the first half of 2020 had an ESG theme. From an asset management perspective, this is where the action is.
I believe this is leading to two things – product convergence and a fusion of the distribution channels.
It is notable that asset managers have started converting some of their mutual funds into ETFs. Credit Suisse and Vanguard are two of them. Credit Suisse specifically cited the importance of accessing digital channels geared to stock market transactions. It chose three ESG funds to set the ball rolling.
Hand in hand with this is a shift towards active management. While ETFs have historically been passive index products, there is a new wave of actively managed ones being launched. In the US, there have been more active ETFs launched in the past year than passive ones.
It is no coincidence, I suspect, that Blackrock has unified the management of its indexed investment funds and ETF businesses under the same top executive.
All of this argues for a fusion of the distribution channels. Asset managers looking to merge or combine investment funds with ETFs have global business models and want global distribution. They want to be able to streamline their operations around a big and highly efficient technology platform.
Happily, that meets the requirements of big investors. They want to be able to invest in liquid products that will be easily tradable on different markets in different time-zones. And they want to be able to do that in the same way they buy their direct securities holdings. The rush for ESG assets has simply given the process added impetus.
Of course, there will be plenty of asset managers who will be happy to remain local players with their own regional sales networks. Equally, it is worth noting that there are investors who are not allowed to invest in ETFs. This fusion of products and channels may not apply to the whole asset management industry.
For the investment funds industry the pivot towards ETFs is only part of the story. The goal must surely be to get mutual funds distributed in the same efficient manner as ETFs and also traded on-exchange. The ability to reach both retail and institutional clients by way of the same channel may sound like a pipe-dream right now; but product convergence is bringing it closer by the day.
As Global Head of Capital Markets and Funds Services at Euroclear, Stephan Pouyat cares passionately about aligning the financial sector with moves to accelerate development among the world's emerging economies.