Investors trend to physical asset tracking ETFs

The US model followed by ETF managers, using a basket of physical assets to track an index, appears to be winning in terms of popularity versus the European model of synthetic ETFs, which use derivatives to replicate index returns. The trend by investors to opt for physically-backed funds has seen the market share for synthetic replicated fund drop to 25%, a ten-year low.

European ETF inflows experienced their best-ever year in 2015, with net inflows of EUR70.8 billion, surpassing the previous high of EUR51 billion recorded in 2008, according to Morningstar’s 2015 ETF fund flows report.

The firm writes: “The record-breaking trend began early, as the industry posted its highest-ever quarterly flows in the first quarter of the year, and after a second-quarter lull, picked up a record pace again in the second half of the year. The combination of record net inflows plus overall capital appreciation across most asset classes of EUR19.6 billion pushed assets under management (AUM) in ETFs up by 24 per cent year-on-year to EUR467.4 billion.



Further findings from Morningstar’s 2015 ETF fund flows report include:







· Investors showed a clear preference for equity market exposure—equity ETFs gathered EUR42.7 billion of net new money (60 per cent of total inflows) during the year.



· Investors expressed a strong preference for European stocks, while emerging markets—particularly China—went out of favour.



· Fixed income continued to attract solid interest in spite of low yields and increased volatility in areas such as high yield.



· Net flows into commodities were more than offset by a drop in market value across the asset class.



· iShares retained its strong leading position with 46 per cent market share. db X-trackers and Lyxor reaped the rewards of switching to physical replication as the wider European investor base has shown a clear preference for physical products over the past few years.



· Market share for synthetic replication continued to drop, hitting a decade-low below 25 per cent. Currently at industry-wide level, with the exception of a minority of providers, the synthetic replication method is either dismissed or only used when physical replication is not deemed a viable option.



Jose Garcia-Zarate, senior passive strategies research analyst for Morningstar, says: “The data seems to indicate that the European ETP industry has entered a phase of strong growth; giving credence to industry predictions that foresee AUM hitting the EUR1 trillion mark by 2020. This trend is underpinned by growing awareness of the European investor community on the benefits of low-cost investing.”