Ciaran Fitzpatrick of State Street Institutional Services paints a vibrant picture of the evolving landscape for Exchange-Traded Funds (ETFs). Across the investment world, the move from active to passive is not just a trend but a shift that is being felt across retail and institutional investments, largely due to persistent pressure on costs. Ireland and Luxembourg present different appeals to new issuers.
“Large asset managers now are asking themselves how to get into ETFs in Europe. What is my strategy going to be? Typically what we are seeing now is that they are moving active mutual strategies into ETFs. That trend is very much at its infancy,” said Fitzpatrick, managing director and head of ETF Solutions Europe at State Street.
Traditionally, mutual funds have been favoured by institutional wealth managers and banks for portfolio building. However, the increase in knowledge and awareness about ETFs among both the sell- and buy-side is reshaping this paradigm. Besides providing a broader range of exposures, from emerging markets to focused global portfolios, ETFs also offer substantial cost advantages. Fitzpatrick estimates that active ETFs typically save 20 to 30 basis points, and standard funds between 10 and 20 basis points, compared to mutual funds.
Building blocks
“We are seeing a move from active to passive and a lot at extremely high costs,” Fitzpatrick said from his Dublin office. “It’s not just retail investors but institutional investors are using them as building blocks within their portfolios to achieve a return. A lot of it just comes down to costs and awareness of the return on what you get out of these.”
A notable trend is the increasing use of actively managed ETFs in model portfolios by investment managers in Europe, a strategy borrowed from the US and North America. The trend is also described as “ETF 3.0”. Unlike passive, traditional ETFs, which accurately track an index, an active ETF can be adjusted by a manager by adjusting the weighting of certain assets - think of a company that’s unexpectedly underperforming.
The active ETF market remains relatively small, holding 26 billion USD at the end of last year, a mere fraction of the 1.480 billion in European ETFs. However, among the world's top 50 asset managers, 34 have already adopted ETF strategies, with another six to nine firms operating as investment managers for ETFs.
‘Technology to access returns’
Fitzpatrick strongly emphasises that ETFs aren't a distinct asset class from mutual funds but rather represent a technology that offers a different way to access returns, usually at a lower cost. This understanding is fueling asset managers to initiate ETF strategies, even as mutual fund costs decline.
Abrdn, the Edinburgh-based asset manager, is the latest entity to embrace actively managed ETFs in Europe. State Street began collaborating with Abrdn two years ago on planning and strategizing their European ETF range, culminating in the launch of abrdn’s Global Real Estate Active Thematics Ucits ETF in May. “The first product going live marks a great milestone for both firms,” Fitzpatrick said.
Europe leaning heavily towards active
Fitzpatrick doesn't believe Europe is lagging behind the US. In fact, he identifies considerable growth in various sectors, particularly a surge in ESG products, which accounted for over 60 percent of primary market flows into ETFs in 2022.
Top operators of Luxembourg-domiciled funds, such as Amundi and BNP, are following the shift towards Dublin as Europe’s primary ETF hub, drawn by Ireland’s tax treaty with the US. Amundi is gradually replicating its 15 billion euro suite of Luxembourg-domiciled ETFs in Ireland.
The choice between Luxembourg and Ireland for ETF domiciliation has been intriguing.
Fitzpatrick observed that tax advantages and the overall ecosystem contribute to new issuers' decision in domiciling their products. "Many new issuers entering the ETF market who decided to launch and domicile their products in Ireland cited tax advantages as one of the reasons."
Luxembourg flexibility
Luxembourg's edge lies in its flexibility with listed and unlisted share classes. Here, asset managers with active strategies can simply add an ETF class without needing to rename the entire fund. Fitzpatrick acknowledged this as “a potential advantage for Luxembourg”, especially for managers who already have an existing strategy in Luxembourg, where they run fixed income funds “They can just add a share class,” he said.
On the other hand, Ireland’s taxation treaty with the US gives funds investing in US equities a 15% withholding tax discount – Luxembourg has a 30% tax rate at the fund level for both mutual funds and ETFs. Therefore, new issuers planning to launch equity products are likely to domicile in Ireland, Fitzpatrick said.
‘No point in having a split’
“Very few managers would consider launching a fixed-income only or an equity-only range. If the manager has any intention of launching equity products and needs a new legal structure, they are likely to domicile both equity and fixed income in Ireland. To these managers, there is no point in having a split.”
Fitzpatrick forecasts that active growth across Europe will shape the future of ETFs. While Ireland might take the lead, Luxembourg could also witness growth, especially from managers who might introduce active products to their Luxembourg range. Amundi's potential transition of ETF equity products with US exposures from Luxembourg to Ireland is one development to watch out for.
"For pure fixed income, active managers like Amundi might continue adding an ETF class in Luxembourg. Anything beyond that, we are likely to see in Ireland. That's not an opinion, but what we are witnessing in the market," Fitzpatrick concluded.
