The importance of retail investors in the European ETF market is a hot topic for providers and regulators alike. Pundits are quick to point out that in the US, retail investors play a significant role in the growth of ETFs. Are they the key to future growth of the European industry? If so, how? Will they change the range of exposures offered? Is there a massive education programme on the horizon? The obvious answer is that anything is possible. But what timeframe can we plan for? Probably five years?
Market structure
The arrival of the Euro was supposed to herald the creation of one common market for financial products and this is largely true for institutional investors. However, for retail investors a multitude of languages, diversity of regulatory regimes and over twenty national stock exchanges mean that this is not really the case. Structural fragmentation leads to significant behavioural and zeitgeist-related national differences in investment behaviour. The UK's contract for difference (CFD) business boomed while German investors delved into structured products and schuldschein. Spanish investors poured money into competitively priced traditional funds while Swiss investors showed enthusiasm for structured deposits. Rarely is one product or exposure the hot topic across Europe.
Distribution
For a retail investor, products don't just arrive on your doorstep. Providers and distributors have to work quite hard to get them to you. And this distribution process is time-consuming and expensive both explicitly and through opportunity cost. If a provider's shelves are too crammed with product nothing gets sold. And for a retail distributor, it is clear that offering a product can be deemed tantamount to recommending it; witness the number of institutions that had to make investors whole on their Madoff investments even though they had highlighted that the products were sold on a
caveat emptor
basis. When products misbehave, it is usually self-defeating for the distributor to try and remind customers that they were warned from the beginning. As a result, distributors need to have both conviction and motivation to introduce unfamiliar products.
Product awareness
ETFs, and passive investment more broadly, exist to give investors investment tools. They are there to help them implement their investment views to the extent that they have conviction. This is the rub. How many non-professional investors have strong views that they are itching to risk their hard-earned capital to pursue? Further, if they have conviction, do they have confidence in their own product knowledge to select a fund from the thousands on offer? These two challenges seem to drive most private investors to choreographed solutions. This is where wealth platforms ask the investor for their views and then offer a limited number of outputs, all executed in products that professionals have vetted. There are exceptions. Italian retail investors are known for their independence. They trade actively on exchanges with a notable appetite for moving further out the risk/return spectrum. But this is the exception rather than the rule and with over €10tn in managed assets in Europe, institutional investment dwarfs any discretionary retail flows.
‚ÄãSo what is next?‚Äã
Retail investors have been buying funds for centuries. Today they have more information than they have ever had before. Disclosure has been scrutinised and standardised. Investment details are posted on websites. Asset prices are just a Google away. Nonetheless, the Central Bank of Ireland's recent 100-page ETF discussion paper is a testament to how the product issues are global and need to be discussed and understood in order to continue to support the growth and development of UCITS ETFs. Ultimately, relatively simple and highly-transparent UCITS fund structures are bound to eventually elicit nods of approval rather than furrowed brows and rumbling concern.
There are many changes on the investment horizon that could prompt a spike in retail interest ‚Äãin passive investment tools, including ETFs. However, as distributors have to pour considerable effort into promoting any unfamiliar investment, a spike in retail investment in passive funds and ETFs is unlikely to take the market by surprise. In sum, as the growth in institutional investment continues apace, it is difficult for any but the most patient providers to justify putting retail at the top of their focus list.
