By Alexis Marinof
Historically there has been a relatively low penetration of ‘direct’ investments into ETFs by UK pension funds.
One key reason is the high level of intermediation and propensity for schemes to outsource most or all investment functions. Another may be the lingering misperception ETFs are more expensive than competing structures and thus not appropriate for widespread use.
Whatever the reason, UK schemes would be well served to start evaluating ETFs alongside other, more common implementation options. With rapid growth in asset gathering comes lower costs to the investor, and the range of investment exposure available has also grown notably.
Today, there are many segments of the investment landscape – e.g. emerging markets local currency bonds, small cap stocks and smart beta – where few, if any, traditional passive pooled fund options are available; so for schemes seeking such assets, ETFs may be the only investable option.
Another possible driver of flows into ETFs by pensions is regulation. Despite still being in draft, directives such as IORP II loom on the periphery of many trustees’ minds. The directive, based on Solvency II, will take a ‘look through’ approach to any collective investment vehicle, such as a traditional fund or an ETF. Previously any ETF would be treated as an equity no matter what the underlying assets were.
However, with a look through approach a fixed income ETF – for example –could be charged the comparatively low capital charge of the ETF’s underlying bond holdings whilst still benefitting from its specifics, namely trading as a single unit with daily liquidity and a closing price.
Year-on-year flows into fixed income ETFs globally have increased by 19% totalling close to 80bn US$ as of end December 2015. With IORP II on the horizon, issuance of domestic government bonds (historically a popular asset class among UK schemes) drying up, and DC trustees now legally obliged to measure the ‘value for money’ of their scheme the propensity to use ETFs for core, fixed income holdings is set to increase.
Alexis Marinof is EMEA head of SPDR ETFs
