INTERVIEW: How are ETFs evolving?

Exchange-traded funds (baskets of investments that are traded on exchanges with a live market price) are currently undergoing huge growth, especially those incorporating active strategies.

In this interview, Pawel Janus, the CEO and co-founder of analytics platform ETFBook, explains how the ETF space is evolving.

You talked recently about the ETF space being “transformed” – what are the big trends you see in the market?

On the one hand, you have had massive innovation in the indexing space – it is not any more about tracking plain vanilla “boring” ETFs.

There has been massive innovation in providing exposure to thematics and fixed income. You obviously have the inclusion of new asset classes like digital assets, such as cryptocurrency ETFs and ETPs.

What is ahead of us is a boom for actively managed ETFs. There are quite some tailwinds for this transformational change, obviously the biggest being the US drive where mutual funds are not as tax efficient as ETFs. That’s why you have a massive convergence of traditional mutual funds and ETFs in the US and Europe, which is usually a little bit lagging the trend but is effectively also following the transformation.

So you see a lot of traditional asset managers eyeing entry into the ETF space.

I think the industry has recognised that ETFs are not just an instrument for tracking vanilla indexes, but can effectively include any other strategies you want. It can be single asset, multi-asset, with a high or modest active share. What changes effectively is the distribution model of ETFs – you don’t have the distribution model that you have in the traditional mutual fund space but you just list the product on an exchange and it is available to anyone who has an application to trade securities.

What explains the burgeoning demand for ETFs?

ETFs tend to be more tax-efficient wrappers than traditional mutual funds.

ETFs also offer great flexibility in terms of accessing a strategy. If you’re convinced an asset manager can deliver alpha or is doing better in terms of risk management, or is doing better work in handling governance and ESG you can buy the ETF on an exchange.

If you observe the strategy and you’re not happy you can exit very easily.

All the merits of ETFs have been demonstrated to apply also for active managed strategies (in the past ETFs have been passive trackers). In that sense a whole new set of opportunities for active managers is out there.

On the other hand, it’s very clear that these active managers have to deliver on their objectives, whether delivering alpha or whether doing better work in terms of risk management.

How do you see ETFs transforming in the future?

A big question is what will happen with private assets. You’ve seen, for example, BlackRock bought the Preqin platform last year (a database providing information on private assets).

You see a lot of discussions around companies such as Apollo or KKR who are seeing whether some portion of private assets can be wrapped into an ETF, and what to put on the exchange to enhance liquidity and access to these things.

This is not something that will happen soon but there are a lot of discussions and I think this is also going to transform the industry in the next few years as well.

Will the liquidity limitations of private assets be overcome?

I think it’s a question of time. There’s always this notion of lack of liquidity, lack of proper market making activities etc. What has changed in the fixed income and crypto spaces, and what will change in the distant future in the private asset space is the infrastructure has to improve.

You can create a basket of ETP shares, providing exposure to 50 underlying cryptocurrencies and it is no big deal. So, when you have infrastructure and technological advancements, this allows the inclusion of more modern asset classes such as crypto or maybe private assets.

I don’t think things will change overnight, it’s effectively an evolution that is happening day by day.

When the first fixed income at bigger scales were launched about 10-12 years ago, people were concerned about the liquidity – for example when bringing emerging market bonds or inflation linked bonds, high yield strategies or even development bank bonds or segments that are not accessible at ease.

All of a sudden you can go to the exchange and buy an ETF, providing exposure to the entire high yield USD segment.

How do you see the big asset managers adapting to the changes you’ve mentioned?

It really depends on the segment because obviously pension funds would have very different needs to family offices/asset managers while deploying ETFs for fund-of-fund structures.

The diversity of customers also implies they have different needs. Generally speaking, the big guys like BlackRock and Vanguard will have their own offering which is very cheap, sizeable funds, easy to access.

Obviously you will have issuers and providers who are deeply specialised in certain segments. And fund selectors like asset managers use certain criteria to select managers based upon these deep capabilities.

You will have a growing need for solutions such as currency-hedged capabilities embedded into the ETFs. There are a lot of providers who have gone towards blending different assets.

You have now in the US in particular, less in Europe, a lot of ETFs that blend equity with some option strategies. There is an avalanche of strategies that allow you to generate additional income or target lower risk strategies.

You have innovation with regard to target date for fixed income, so you buy the ETF and effectively keep it until maturity.

You have different applications of ETFs by different segments. Pension funds, family offices, hedge funds and wealth managers for example all have different needs. At the other end of the chain, you have retail customers who are increasingly using ETFs for either short-term investments or maybe for long-term pension savings.

The transcript has been edited for clarity.