(Citywire Selector) - Few financial tools have experienced the same evolutionary journey as ETFs, which first hit the market in 1990 to little fanfare.
Invented in the late 1980s by the Toronto Stock Exchange, ETFs were considered an insignificant niche before the 2007-08 financial crisis. However, by 2020 they accounted for $7tn (€6.07tn) of global assets.
But things are set to move on again. By 2025, most financial advisers will be using web-based software to create and manage customised indices for their clients.
This is according to Patrick O’Shaughnessy of O’Shaughnessy Asset Management, whose custom indexing platform, Canvas, offering bespoke or ‘hyper personalised’ ETFs, was recently bought out by Franklin Templeton.
Custom indexing asks the question: Why should we all own the same S&P 500 stocks? A more tailored approach caters for people who don’t want to own companies with certain characteristics, such as tobacco or oil.
For some, custom indexing is passive investment’s greatest advance since ETFs first hit the market. Others are keen to stress that it is a democratising tool, enhanced by technological strides.
However, the reality of this latest development lies somewhere between the views of its passionate advocates and its detractors.
THE CASE FOR SPECIALISED ETFS
Thematic ETF specialist Rahul Bhushan from Rize ETF said he sees a large opportunity in the space.
‘We believe this area will get much, much bigger than the small size it currently occupies in terms of assets. A lot of money is going to move into thematics.’
Rize ETF owns the commercial rights to all of its indices which it develops in-house. Not being a regulated indices provider itself, Rize passes them onto one, and then licenses them back.
For Bhushan, much of today’s conversation around custom indexing comes down to shifting attitudes among investors.
‘The reason for this conversation is largely due to sustainability. One person’s definition of sustainability is very different from another’s, and the same is true for thematics.
‘So, if you want to invest in cybersecurity, you might find two or three ETFs, but you might have a very different idea of which types of companies should or shouldn’t be in a cybersecurity portfolio.
‘You might then say “OK, I don’t like these ETFs over here, so I am going to create my own”. This is how these conversations start.’
Speaking about the potential for more bespoke indexing, Bhushan said that some of the most sophisticated users are those who want to trade options or volatility inside of indices.
However, he added the most important aspect for investors will continue to be well devised investment strategies, whether it is through an ETF or a more traditional fund.
CAUTIOUS ADMIRATION
The biggest innovations in the space have been the direct trading platforms, rather than the direct indexing itself, said liquidity provider GHCO’s head of fixed income, Roxane Sanguinetti.
Sanguinetti believes there is nothing new or innovative about direct or custom indexing.
‘That’s not to say that great and innovative technologies aren’t being developed to make it more available and user friendly, but large asset managers have used the basic screening tools of the larger market to create alpha portfolios for years,’ she said.
For Sanguinetti, custom indexing and ETFs are complementary. ‘It’s not necessarily that the two are in direct competition, it’s more that they could complement each other, and I expect we will see a lot of acquisitions by bigger ETF providers to complement their offering.’
ESG AND TECH GAME-CHANGERS
The question as to how new or revolutionary custom or direct indexing is, depends on who you ask, according to Athanasios Psarofagis, an ETF analyst with Bloomberg Intelligence.
‘Direct indexing has existed for a very long time. It used to be known as separate managed accounts, which were typically reserved for institutions or advisers that had clients with a very high investment threshold.
‘But it is the advance of new technology that creates the platforms which give people greater access to it. The wrapper itself has been around for a long time, but the strategies packaged into the wrapper have undoubtedly become more innovative.’
‘I think direct indexing will surprise people in terms of how much it raises, but I don’t think it’s going to be like an ETF killer. I can’t see it trumping ETFs anytime soon’
Athanasios Psarofagis, Bloomberg Intelligence
Overall, Psarofagis said what people are really after is ESG technology.
‘What these direct indexers are really buying in these recent acquisitions is the ESG technology.
‘I think direct indexing will surprise people in terms of how much it raises, but I don’t think it’s going to be like an ETF killer. I can’t see it trumping ETFs anytime soon.’
Considering that ESG is the fastest growing segment in the ETF space, Psarofagis’s point holds water.
Chris Mellor, Invesco’s head of Europe, the Middle East and Africa (Emea) ETF equity, pointed to ESG’s huge growth within the space. ‘Year to date, almost 50% of Emea ETF flows have been into ESG products. Last year, that number was about 40%. And that’s growing from a relatively low level.
‘Today just over 10% of total ESG assets are in the ETF space, compared with about 4% in 2020, which shows an enormous growth in just over 18 months.’
ETFs saw uplifts in popularity after two large economic upheavals, the first being the dotcom crash in 2001, followed by the 2007-08 financial crash.
Asked if it is any coincidence that we are having this conversation about ETFs after a global pandemic, Mellor said something as significant as Covid-19 can start to focus people’s minds.
He added we are now seeing a more ‘grown up’ approach to ESG, as people realise it is about far more than exclusion and viewing oil and gas as ‘the bad guys’. This, in turn, influences people’s view of ETFs and sustainability.
By Krystle Higgins
December 6, 2021
