Exchange-Traded Funds in Europe PDF
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EXCHANGE-TRADED FUNDS IN EUROPE EXCHANGE-TRADED FUNDS IN EUROPE A M DAM ARSZK GdanskUniversityofTechnology,FacultyofManagementandEconomics,Gdansk,Poland E L WA ECHMAN GdanskUniversityofTechnology,FacultyofManagementandEconomics,Gdansk,Poland AcademicPressisanimprintofElsevier 125LondonWall,LondonEC2Y5AS,UnitedKingdom 525BStreet,Suite1650,SanDiego,CA92101,UnitedStates 50HampshireStreet,5thFloor,Cambridge,MA02139,UnitedStates TheBoulevard,LangfordLane,Kidlington,OxfordOX51GB,UnitedKingdom Copyrightr2019ElsevierInc.Allrightsreserved. Nopartofthispublicationmaybereproducedortransmittedinanyformorbyanymeans,electronicor mechanical,includingphotocopying,recording,oranyinformationstorageandretrievalsystem,without permissioninwritingfromthepublisher.Detailsonhowtoseekpermission,furtherinformationaboutthe Publisher’spermissionspoliciesandourarrangementswithorganizationssuchastheCopyrightClearance CenterandtheCopyrightLicensingAgency,canbefoundatourwebsite:www.elsevier.com/permissions. ThisbookandtheindividualcontributionscontainedinitareprotectedundercopyrightbythePublisher (otherthanasmaybenotedherein). Notices Knowledgeandbestpracticeinthisfieldareconstantlychanging.Asnewresearchandexperiencebroaden ourunderstanding,changesinresearchmethods,professionalpractices,ormedicaltreatmentmaybecome necessary. Practitionersandresearchersmustalwaysrelyontheirownexperienceandknowledgeinevaluatingandusing anyinformation,methods,compounds,orexperimentsdescribedherein.Inusingsuchinformationormethods theyshouldbemindfuloftheirownsafetyandthesafetyofothers,includingpartiesforwhomtheyhavea professionalresponsibility. Tothefullestextentofthelaw,neitherthePublishernortheauthors,contributors,oreditors,assumeany liabilityforanyinjuryand/ordamagetopersonsorpropertyasamatterofproductsliability,negligenceor otherwise,orfromanyuseoroperationofanymethods,products,instructions,orideascontainedinthe materialherein. BritishLibraryCataloguing-in-PublicationData AcataloguerecordforthisbookisavailablefromtheBritishLibrary LibraryofCongressCataloging-in-PublicationData AcatalogrecordforthisbookisavailablefromtheLibraryofCongress ISBN:978-0-12-813639-3 ForInformationonallAcademicPresspublications visitourwebsiteathttps://www.elsevier.com/books-and-journals Publisher:CandiceJanco AcquisitionEditor:J.ScottBentley EditorialProjectManager:KaterinaZaliva ProductionProjectManager:PoulouseJoseph CoverDesigner:MilesHitchen TypesetbyMPSLimited,Chennai,India Foreword Exchange-traded funds (ETFs) have been around for more than a quarter of a century, yet they continue to be innovative financial products with tremendous growth of market share andassets undermanagement.This inno- vation also continues to develop new varieties in terms of market coverage and types of traded portfolios. The first and probably the most well-known ETF product in the market is SPDR that tracks S&P 500 and has the larg- est share and trading activity in the ETF market. It took almost a decade for ETFs to get traction and attract inter- est among investors from the time of its introduction. Currently, the variety of ETFs is vast not only in terms of the indexes they cover within an asset type (broad index, industry, sectors, international, and country specific, among others), but also the types of assets (equity, fixed-income, commodities), portfolio holdings (physical vs synthetic), andintensity of portfolio management (active vs passiveETFs). As recently summarized in a Wall Street Journal article on October 8, 2018, there are almost a dozen strategies that ETFs follow. The two oldest strategies are a passive strategy, which entails index tracking, and an active strategy, which entails selecting securities to try to outperform a benchmark index or manage downside risk. These are used by many fund types including ETFs, mutual funds, and closed-end funds. More recent and inno- vative strategies are: smart beta—typically any ETF that weighs holdings differently from market capitalization; factor—index funds and ETFs that weigh portfolio holdings based on security attributes such as size, value, and momentum; multifactor—similar to the factor strategy but also attempts to derive returns by including more than one factor; tilt—slightly overweighs stocks in the index with certain characteristics and may indicate a pre- ferred investing style such as value or growth; quantitative—based on technology and math-driven investment decisions; self-indexed—an ETF product based on an index without licensing fees in an attempt to reduce costs; leveraged and inverse, and inverse leveraged—uses core index holdings in combination with futures or swaps to generate daily multiple returns of an index or sector; thematic—a step beyond industries and sectors to follow market trends; and hedged—indicates some level of risk control, often using short-selling, options, futures, or swaps. As ETF products and markets continue to grow and develop its complexity, investors need more information resources and education on these products. There is growing literature in academic and practitioner research that tries to shed some light on different aspects of ETFs and their influence on the markets. Earlier studies looked at performance and characteristics of ETFs, such as tracking errors, fees, and flows and compared ETFs to other similar products such as mutual funds and closed-end funds. As ETFs continue gaining a substantial share of the market, investors, practitioners, academics, and regulators alike started to raise questions on the systemic effects of ETFs on underlying securities and markets. This led to the development of a trench of literature that looks at the effects of ETFs on liquidity and volatility of underlying securities and markets, and spillover effects. There are alsoafew books that detail ETFs’ operationandassessmentofETF choices.Some booksalso provide summa- ries of academic research on ETFs. However, given the continuing evolution of the ETF markets and products, there isa need for more research and publications, both peer-reviewed and educational. This book is a good addition to the existing list of publications on ETFs. Main difference of this book from others is that its focus is on European ETF markets, which is second in size after the one in the United States, but relatively less studied or covered by publications in comparison to the US ETF counterparts. Why is covering the European market important? It is a large and growing market, yet has regulatory, organizational, and cultural differences. The book is a combination of educational materials on ETF concepts, functionality (Chapter 2: Exchange-Traded Funds: Concepts and Contexts), and history of European ETF market (Chapter 3: Exchange- Traded Funds Markets in Europe: Development Patterns), as well as providing empirical studies on the vii viii FOREWORD determinants of the European ETF market development (Chapter 4: Determinants of the European Exchange- Traded Funds Markets Development) and integration of the European ETF market with the European financial system (Chapter 5: Exchange-Traded Funds and Financial Systems of European Countries: A Growth Factor or Threat toStability?). Dr. Anna Agapova FloridaAtlanticUniversity, Boca Raton, FL,UnitedStates Acknowledgments Our book could not have been developed without the support and constructive criticism from a large number of people. We are deeply indebted to all of them and would like to them thank for their intellectual contribution to this work. We are especially grateful for Prof. Krzysztof Jajuga from the CFA Society Poland and Wrocław University of Economics, and the other participants of the seminars of the Department of Economic Sciences at Gdan´skUniversityofTechnologyfor their supportandvaluablesuggestionsconcerning ourresearch.Our collea- gues were a great source of ideas, encouragement, and inspiration and helped us keep things in the right per- spective. Prof. Tomasz Miziołek from the University of Ło´dz´ provided us with valuable support and his works shaped and directed our thinking and understanding of issuespresented throughout the book. We appreciate the enormous help from all the people involved in processing the large datasets that were used in our research, with special thanks to Jan Marszk. We are also grateful to Dr. Anna Agapova from the Florida Atlantic University for the foreword. Last but not least, we express our gratitude to our families for their enormous patience and under- standingduringthe days and nights spentworkingon themanuscript.Theykept usgoingwith thiswork, which would not bepossiblewithout them. The research presented in this book has been supported by the National Science Centre of Poland (project no. 2015/19/D/HS4/00399). A.Marszk hasreceived support from theFoundation for Polish Science(FNP). As always, theresponsibility for any errors inthe book remains our own. ix C H A P T E R 1 Introduction We are living through a revolution in the way people invest. Never before have so many different investment products been available toinvestors at the click ofa mouse (...). Abner (2016) O U T L I N E 1.1 Background 1 1.3 Structure and Contents 4 1.2 Aims and Scopes 3 References 6 1.1 BACKGROUND That there are various forms of investment funds is undeniably a crucial characteristic of the contemporary financial system. By slightly modifying the definitions of a synonymous concept of “investment companies” pro- vided by Abner (2016) and the Investment Company Institute (2017), and without dwelling into unnecessary details, they can be most broadly understood as financial institutions that gather financial resources from either retail and institutional investors and invest them in securities and other assets in order to reach a range of invest- ment aims; investment funds are managed by investment professionals. Despite the relatively long history of some types of investment funds, their position has become significantly strong during the past few decades, boosted by various economic and social changes, and take place in the most advanced economies. Investment funds are a substantially heterogeneous class of financial institutions that, using the most general classification, covers (yet is not limited to) subcategories such as mutual funds, closed-end funds, exchange-traded funds (ETFs), private equity funds, and hedge funds. Moreover, investment funds have a broad range of investment aims, offering exposure to numerous asset classes in many sectors as well as countries and regions. Investment funds are also highly diversified in terms of their other attributes, including their legal form (vastly depending on the country-specific regulations or the structure of the local investment industry) and construction (with spe- cific examples such as umbrella or master-feeder funds). During recent years the development of investment funds can be noticed globally in many dimensions including the two key perspectives: their assets and number. Substantialgrowth has alsooccurred in mostcases onthe country level. In spite of the substantial and still increasing diversity of investment funds, most people (even in the group of the financial professionals) associate this category of financial institutions exclusively with the mutual funds that generally overshadow other types, such as closed-end funds or ETFs. Mutual funds are available all over the world in the majority of advanced and emerging economies; however, in the poorest countries their availability remains severely limited due to the underdevelopment of the local financial systems. These mutual funds are also the most diversified type of investment funds. The global assets of mutual funds as of the end of 2017 reached a record-high level of $45 trillion, out of which approximately 80% were managed by the United States and European funds, and most of the remaining by the Asia-Pacific institutions—estimations based Exchange-TradedFundsinEurope. 1 DOI:https://doi.org/10.1016/B978-0-12-813639-3.00001-8 ©2019ElsevierInc.Allrightsreserved. 2 1. INTRODUCTION on ETFGI (2018) and Investment Company Institute (2018)—which indicates the high level of the global market’s concentration. Obviously, the focus on mutual funds can be explained by their domination on the global investment funds market. However, it should not be forgotten that this was not always the case. If we consider the United States—the world’s largest financial system (and also the biggest investment funds market) that is strongly linked to financial sectors in other countries through a broad array of interdependencies—we may clearly see that, in the early 20th century, closed-end funds were the dominant category and mutual funds had marginal importance mostly due to their later launch (Abner, 2016). However, starting from the stock market crash of 1929, over the next decades the position of closed-end funds sharply declined while, at the same time, mutual funds emerged as the leading institutions in the investment industry. There were some moments of increases in the popularity of closed-end funds yet these were rather short-lived (interestingly, one of the most recent episodes was interrupted by the rise of ETFs). This shows that the structure of the market for investment funds should not beregardedasdefiniteasithasundergonechanges,attimessuddenandradical;theUnitedStatesisnotuniquein thismatter asinvestment fundmarkets have alsoevolved in other regionsalbeit thatthe exactchangeshave some- times significantlydiffered. Moreover,itmeans thattheleadingpositionofthemutualfundsmay bethreatened by the other categories of investment funds as well as some developments in the financial system. One of the main contestantsis ETFs—investment funds thatcombinethe attributes of various categories offinancial institutionsand products,andoffertheirusersarangeofpreviouslyunavailableinvestmentpossibilities. The evolution of the investment funds market over the past several years should not be considered without taking into account the events in the global economy, in particular those that affected the global financial system, such as the 2008 financial crisis or the unparalleled spread of information and communication technologies (ICT) with their profound social and economic implications (Lechman, 2015). As emphasized in the opening citation from Abner (2016), technological revolution has in many ways influenced the investment industry, offering alternatives to the most frequently used bank deposits being accessible as probably never before and increasing the competition among providers of various investment services. More generally, ICT has reshaped all aspects of the financial system, starting from the services provided by banks, through to insurance for all dimensions of the financial markets(e.g.,processingof transactions, access to information), among many others. From a slightly different perspective, one ofthe key trends that shape theinvestment industries in many coun- tries is the growing popularity of passive investing (indexing). The basic concept of passive investing is to track (replicate) the performance of the selected index (in other words, the performance of a specified market or a seg- ment of it) rather than to try to outperform it. The reason for such strategy being, inter alia, the after-cost advan- tage in relation to active investing (Malkiel, 2016; Sharpe, 1991). Regardless of the possible objections to such an approach, its increasing popularity in the global investment industry is undeniable. It would be impossible with- out the introduction of the new category of investment funds that corresponds perfectly to the main assumption of passive investing—ETFs; however, the cause and effect are not so straightforward as, at the same time, the launch of the first ETFs appears to be an offspring of the heated discussion of the possible advantages of indexing. The rapid expansion of ETFs is one of the key processes that have taken place in the investment industry (yet its pace differs substantially in various regions and countries; in some there are still no such investment funds). Within several years since their launch they have moved from a marginal product, almost unrecognized on a global scale, to a part of the mainstream financial industry. However, they have not lost their “innovative spirit.” ETFs can still be labeled as financial innovations as ETFs markets experience continuing innovational activity with the launch of new types of funds, giving more people access to the increasing group of assets and invest- ment strategies. It may be stated that the launch of the first ETF can be regarded as one of the milestones in the global financial history. Such a designation can be explained not only by the broadening of the range of invest- ments available to their users, but also by the emergence of the new segments of the financial system, such as robo-advising, that were impossible or unfeasible to offer before the advent of ETFs. It should, thus, not be sur- prising that launch of ETFs and development of the ETFs markets are described by Madhavan (2016, p. 3) as a “disruptiveinnovationtotoday’sassetmanagementindustry”andbyAbner(2016,p.XVII)as“themostinterest- ing products in the financial industry today.” It would, thus, not be an overstatement to regard them (with the usual caution) as a revolution in thefinancial industry. The rising popularity of ETFs has resulted in the burgeoning academic literature devoted to this topic, with a vast number of interesting studies that address various aspects of this group of investment funds considered from various perspectives. Most previous studies focused on the key attributes of ETFs as tools for passive investing(e.g.,theirperformanceasfundstrackingcertainindexes)orthewaysparticularfunds affecttherelated EXCHANGE-TRADEDFUNDSINEUROPE 3 1.2 AIMSANDSCOPES assets. There are obviously also many nonacademic publications that show various dimensions of ETFs, in many casesaimedateducating investorsinterestedinthis rather new partofthefinancial sector. Nevertheless,publica- tions that cover the entire ETFs markets (in certain regions or countries) and the position of ETFs in the financial and economic system (including interdependencies between ETFs and capital markets) are rather rare. Moreover, the issue of the determinants of the development of ETFs markets (e.g., role of new technologies) remains, to large extent, unexplored. We attempt to fill these gaps, following, among others, the earlier stream of research that examined the factors behind the development of the mutual funds industry, with the seminal works of, for example, Klapper, Sulla, and Vittas (2004) or Khorana, Servaes, and Tufano (2005). Our discussion covering the main features of ETFs, their position in the investment industry, and the environment of ETFs markets draws heavily from the excellent books (the list is by no means exhaustive) by Ferri (2009), Gastineau (2010), Hill, Nadig,andHougan(2015), Abner (2016), and Madhavan (2016). It must be underlined that in our book we adopt a somewhat different focus and we do not present in detail the general issues that constitute a crucial part of the discussion concerning ETFs suchas the advantagesand dis- advantages of passive investing or indexing (for more details see, for instance, Sharpe, 1991, 2013; Ferri, 2011; Ellis,2015;Bogle,2016;Malkiel,2016;Schneider,2017;Sialm &Sosner, 2018;foranexcellentreviewofthecurrent state of research on mutual funds see Diltz & Rakowski, 2018). However, we briefly discuss them within the out- line of the main features of ETFs and the relationship of these investment funds with the other parts of the eco- nomicand financial system. 1.2 AIMS AND SCOPES Our book covers ETFs in European countries. We include in our analysis almost the entire group of these investment funds on the European exchanges (according to the criterion of primary listing; some yet rather insig- nificant exclusions stem from problematic issues from a methodological perspective). Despite the position of Europe as the world’s second-largest ETFs market (in terms of the aggregate assets in the region), most previous academic and nonacademic publications were highly US-centric—this should not be perceived as surprising due the longest history and largest size (in most possible dimensions) of the US ETFs market (the notable exceptions are, e.g., the papers published by the EDHEC-Risk Institute). However, we believe that for many reasons the European region isparticularly interesting with regard to this part of the investment funds market and requires a separate and detailed presentation that accounts for some of its distinctive features, including the high heteroge- neity of the European ETFs markets, the complicated legal and regulatory environment that experiences dynamic changes—with the crucial role of the law enacted within the European Union (EU)—and the high level of inter- connectedness of the European financial systems (again, related to the cooperation within the EU). Another rea- son that to some extent distinguishes European ETFs markets (yet not all of them) from their counterparts in the other regions is the popularity of certain categories of funds that are absent or rarely available in the United Statesor Asia-Pacific region, the most notable example probably being derivatives-based (“synthetic”) funds. The key aim of this book is to explore the issues associated with the development of the ETFs markets in Europe between 2004 and 2017. We discuss both theoretical and empirical aspects of these innovative funds, yet, to significantly contribute to the present state of knowledge, more attention is devoted to the presentation of empirical results with this respect. In other words, in what follows, we present an exhaustive empirical study regarding the issuesthat werealmost untouched in previous publicationsin the field ofETFs. In the flow ofthis research, we distinguish three major goals: (cid:129) Explaining development patterns of the European ETFs markets (i.e.,diffusion of ETFs) and providing predictions for their possible changes in the future. (cid:129) Identifying seminal factors that influence the spread of this categoryof investment funds on regional and country level. (cid:129) Examining potential consequences of the diffusionof these financial products for the European financial systems by focusingon the impacton thecapital markets and financial stability. In the empirical part of our analysis we study the development of the European ETFs markets in 12 countries by using data on their assets that were aggregated from the fund-level information. Our study covers France, Germany, Greece, Hungary, Italy, Norway, Poland, Spain, Sweden, Switzerland, Turkey, and the United Kingdom. This approach facilitates the detailed examination of a particular country’s achievements in terms of EXCHANGE-TRADEDFUNDSINEUROPE
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