03.12.2013
By Terry Flanagan

Europe’s Institutional Investors Eye ETF Trading Possibilities

Exchange-traded funds (ETFs) are growing in popularity in Europe as a way of sourcing liquidity for institutional investors, as trading volumes in the region remain generally muted.

ETFs, which are funds that track baskets of shares, bonds or commodities and are traded like stocks, were invented in 1993 in the U.S. and have been on an upward growth trajectory ever since due to their low costs and perceived simplicity since they generally track established indexes. Europe, however, is slightly behind the curve but is beginning to catch up.

“ETFs are a growing trend,” said Lawrence Deneault, chief executive of Qarma Technology, a Jersey-based technology platform that says it disintermediates hedge funds and allows asset managers to take back full control of their activities.

‘If you use a baseball analogy, we are in the fourth innings but there is a big baseball game ahead of us. Once people begin to understand how to use these ETFs then you will see people use them as building blocks to build some pretty cool portfolios.”

Generally, ETFs are highly liquid instruments and the percentage of ETF trading relative to overall volumes tends to rise in headline-driven markets when asset classes move together on macroeconomic events.

“There are massive amounts of liquidity if you are dealing in size as you can just go to the market makers to form and de-form an ETF for you,” said Deneault.

Qarma’s platform is for institutional investors who want to implement new absolute return or enhanced beta/tracker strategies to achieve their benchmarks.

“We are seeing a shift on the part of institutions away from outright alpha generation because they have lost the faith and the ability of alpha generating managers to actually generate alpha,” said Deneault.

“They are now tending to focus on enhanced beta or super beta. And so you are seeing institutions simplify to something that is readily understood and slightly outperforms the market. If they beat the market by 150 basis points, frankly a lot of people are happy with that. ETFs are a big building block at achieving that super beta and enhanced beta performance.”

Others, though, claim that despite their relatively low costs and the ability for investors to trade ETFs throughout the day, the ETFs themselves are now becoming extremely complex products—by sometimes using derivatives to simulate the performance of the underlying asset—which is, in turn, creating the potential for greater risks going forward.

The European Securities and Markets Authority, the pan-European regulator, for one, is currently looking to tighten the rules around ETFs.

“A lot of people say that ETFs are catching the uninitiated investor out, but I think that is a very small issue and we are seeing that regulators are trying to legislate out as much as they can the risks—but, in fact, you have to have risk in a financial market otherwise you are not going to make any money,” a London-based market source told Markets Media.

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