EUROPE - Providers of European ETFs can double their funds' stated management fees through ancillary activities such as securities lending, other enhancements and trading activities, says a new research report from Deutsche Bank.
Christos Costandinides, European Head of ETF Research and Strategy, and David Arnold, European Head of Index Research, have co-authored, In the ETF Labyrinth, Where Does The Thread Begin?report which finds that synthetic ETFs are the most profitable type of fund, generating an average gross profit margin of 69% for their issuers, whereas physically replicated ETFs produce an average gross profit margin of 64%.
For synthetic ETFs, the report declares that issuers’ average total revenues are over 1% per annum, more than double the average fund management fee of 0.43%. Deutsche Bank reckons securities lending revenues contribute 20 basis points per annum towards issuers' earnings, while trading by the ETF issuer's associated bank may add a further 35 basis points. Other “enhancements” can add 5 basis points more to the revenues of a synthetic ETF.
When it comes to physically backed ETFs, the main revenue stream adding to management fees that average 45 basis points per annum stems from securities lending, which generates a further 26 basis points. The report reckons other enhancements add 5 basis points, but unlike issuers of synthetic funds, these providers are not able to generate additional revenues from trading.
Physical ETFs operate with management costs that are four times higher than those of synthetic ETFs, 20 basis points per year. Given that these have no need to provide additional collateral, no related charges are incurred. A further 7 basis points per annum for administrative and other expenses bring physical ETFs’ total costs to an estimated 27 basis points, just over a third of these funds’ total revenues.
What the authors are suggesting is the the scale of the revenues that accrue over and above ETFs’ management fees calls into question the traditional fund management model. “The historical premise is that asset managers are independent middlemen who, for a fee, manage assets and look out for their clients’ best interests. In truth, today money management is performed both by asset managers, which are often part of banks, or by banks directly. The model of an independent fund manager providing services in exchange for a nominal fee, while still relevant, is in most cases obsolete. Money managers are not middlemen anymore, the information revolution is forcing them to transform. Money managers are now routinely involved in activities ancillary to fund management, which result in significant additional revenues.”
The report highlights areas of opacity in the ETF market and suggests minimum levels of disclosure that should be adopted by all European issuers. The argument is given that the way ETFs use securities’ lending should be subject to greater scrutiny. The percentage of a fund’s assets that is lent out should be disclosed on at least a weekly basis, while collateral guidelines and details of collateral ownership arrangements should be made clear. Publication of the split of revenues between fund, fund manager and lending agent is recommended as is the practice of obtaining published a legal opinion regarding the protection of investors in the case of a counter-party default.The report also recommends index providers offer better disclosure of their benchmarks’ constituents and of how these are priced. www.db.com
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