The proportions speak for themselves. Half of all US exchange traded fund assets consist of retail money, while in Europe it accounts for just 10 per cent.
For most, the reason is simple: ETF providers do not pay commissions to advisers.
In the US, where fee-based advice dominates, this is not a problem but in Europe, and in particular the UK, where kickbacks are the norm, ETFs are getting ignored.
“It’s straightforward,” says Claus Hein, director of ETF sales at Lyxor, the asset management arm of Société Générale. “The difference with the US is down to the fact that most advisers here have not yet moved from a commission-based to a fee-based model.
“ETFs are low-margin products that don’t provide retrocession fees. This isn’t an issue where fee-based advice prevails, but in the UK, for example, the result is ETFs don’t get sold.”
Julian Hince, director for intermediary business at iShares, agrees. “ETFs have been around in the UK for the past 10 years but they haven’t taken off in retail terms,” he says. “The regulator says there are three main reasons for this: a lack of education; problems with access; and – importantly – the fact ETFs do not pay commissions.”
However, work is being done to correct this. In June 2006, the UK’s Financial Services Authority launched its retail distribution review (RDR) to address what it calls “the many persistent problems” in the retail investment market.
The result is a proposed ban on commissions, shares of profits or any other remuneration advisers might receive from product providers and third parties.
The FSA has also ruled that all investment advisers will now have to be qualified to a new, higher level, regarded as the equivalent to the first year of a university degree.
“IFAs will have to say by 2012 whether they are providing restricted advice or whether they’re truly independent,” says Debbie Fuhr, managing director and head of global ETF research at BlackRock Advisers.
“If an IFA sells a structured product that delivers the same returns as something like an ETF, but at a higher price, and they can’t say why – then that will be addressed by the FSA,” she says.
For an advisory firm to call itself independent it will have to review the whole range of retail investment products – a range the FSA has widened to include structured investment products, unregulated collective investment schemes, investment trusts, and indeed ETFs.
Ms Fuhr is confident such changes will breathe life into the UK’s retail ETF market, and is also convinced it is good news for the rest of Europe.
“Fees are really coming under the scrutiny of regulators across Europe [as a result of RDR],” she says, adding that UK market events, such as RDR, are very influential in terms of European decision-making.
Robert Jenkins, chairman of the Investment Management Association, agrees: “Who is paid by who must become even more transparent. Similar principles must be adopted throughout the EU if the investor is to benefit fully and our industry to enjoy a level playing field.”
France’s asset management association, however, has hit out at the assumption that conflicts of interest exist when retrocession fees are paid.
AFG co-chief executive Alain Pithon says the belief that retrocession payments from fund producers to distributors “automatically create conflicts of interest” is wrong.
These payments “are part of an economic model”, he says, and “to eliminate them would be to misunderstand the work of the distributor, who analyses the client’s situation and selects funds according to the objectives of this client”.
Whether or not he is right, increasing Europe’s proportion of retail assets under management to match that of the US is a tall order considering US retail assets equate to some $350bn (£217bn, €248bn). In Europe the figure is just $22bn.
“I don’t think we’ll get there in the near term, because remember, the RDR doesn’t have to implemented until 2012,” says Ms Fuhr. “Some people are moving faster but [the retail/institutional mix] is not going to leap from, say, 10 per cent today to 30 or 40 per cent straightaway. Over time it’ll get more balanced, however.”
Mr Hince, who was hired by iShares last year to work with UK intermediaries, adds: “Commissions have already become less relevant and we have already seen a change in the fee practices in the UK. Advisers know they can’t wait until 2012 or 2013 to get things moving.”
Lyxor’s Mr Hein agrees: “The retail ETF market is absolutely one of our key priorities going forward. Over the past 12 months the number of queries we get from IFAs has increased significantly. Previously those calls were very sporadic, but that is no longer the case.
“Prior to RDR it was difficult to get a sense of just how big the market could grow, but that has now changed.”