Farley Thomas, head of wholesale distribution at HSBC (HBC) Global Asset Management, talked earlier today to Paul Amery, editor of IndexUniverse.eu, about the bank’s entry into the ETF market.
IU.eu: Farley, what overall goals have you set yourself in the ETF market?
Thomas: We think there’s a good chance that the European ETF market will be around €500 billion in size in three years’ time, and we’re aiming for a 10% market share. Currently the three largest providers [iShares, Lyxor and db x-trackers – IU.eu] have around an 80% market share, which is unusually large in any industry (with the exception of the auto industry, perhaps). So we’d expect those three large firms to lose share while continuing to gain assets, and we think our 10% market share target for 2012 is reasonable.
IU.eu: You’ve announced the launch of a FTSE 100 ETF on the London Stock Exchange, to be followed by ETFs tracking the DJ Euro Stoxx 50 and the CAC 40. What type of replication methodology will you be using?
Thomas: These three funds will all be fully (physically) replicated. That doesn’t mean that we’re opposed to the swap-based model. We think that, pragmatically, ETF providers should have a series of approaches to hand and then deploy the one that makes most sense for the given index. Next year, depending on our launch timetable, we may well start to roll out some funds using partial or swap-based replication.
IU.eu: Will you use securities lending? How will revenues be split with fund shareholders?
Thomas: Yes, we will do so, within the appropriate risk framework. We’re still finalising the details of the stock lending programme, but we will pass on the majority of revenues earned to ETF investors.
IU.eu: Will all these activities take place within HSBC, or will third parties be involved?
Thomas: HSBC Securities Services will be the agent for our lending, and we will be working very closely with our colleagues in the global markets division to use as many of our internal resources as possible. But we want to ensure that the fund gets the best deal and, if necessary, we will go outside the group.
IU.eu: With your FTSE 100 ETF you will be going head-to-head with one of the biggest ETFs in Europe, the iShares fund of the same name. Are you going to compete on fees?
Thomas: We are setting a total expense ratio of 35 basis points per annum, which makes the fund 5 basis points cheaper than the iShares fund, but not the cheapest available on the market [Lyxor, db x-trackers and Source all offer swap-based FTSE 100 ETFs for 30 basis points per annum – IU.eu].
My sense is that the ETF market is growing very rapidly, and a provider like HSBC ought to be able to expand it rather than focusing primarily on taking business away from the incumbents. We are also entering the ETF business as a household name in many countries, under our existing brand. We think it makes sense to do this and that ETFs should no longer be separately branded by many banks, but should be seen as part of the general toolkit that any financial services provider should have.
IU.eu: So why do you think that so many ETF issuers are branded separately from their parent banks?
Thomas: ETFs were an innovation for many firms and many large banks had distinct and large asset management divisions, so it made sense to have separate branding for the ETF business. I think it’s fair to say that five years ago ETFs were seen by many as a disruptive technology. The view we’re very explicitly endorsing today is that ETFs’ disruptive days are over and it’s now a must-have technology for large financial institutions.
IU.eu: Your stated plans are to issue 30-50 ETFs over the next three years. That’s a slower pace of ETF issuance than many other new providers have adopted. Is there any reason for this?
Thomas: Even 15-20 new funds might be sufficient for us – we’re very conscious of the fact that an extreme “80/20” rule applies to the European ETF business, and that there are four equity indices in Europe where ETF assets are largely concentrated (the DJ Euro Stoxx 50, DAX, CAC 40 and FTSE 100). This is where we want to compete, and where our initial fund launches are targeted. Beyond that, we’ll be looking at how to provide the best portfolio building blocks (whether with MSCI or FTSE indices, for example). After the launch of 20 funds, it’s possible that the return on investment for us as a business will tail off, so we’ll be looking closely at what we add. HSBC has a reputation for being risk-conscious, so we’d rather take things slowly and get it right.
A news report in the Financial Times about our launch talks of the “scramble” to enter the European ETF market, but I might use another word, since we’re not rushing our entry. In fact, we believe there’s ample room for another ten large issuers to enter the market and that there’s an undersupply of ETFs from high-quality providers in Europe. On the other hand, there’s an oversupply from niche providers, some of whom may not be around in five years’ time. If you look at the mutual fund industry, there is a huge supply of firms that offer funds, but only about 20 players that do so seriously cross-border.
IU.eu: HSBC also offers a range of index funds – how do you see the relative attractiveness of index funds and ETFs?
Thomas: If you value the tradeability, flexibility and transparency that ETFs offer, obviously you’ll prefer them, even if you can buy a cheaper index fund. If you’re a “wrapping” firm or your processes lean more towards the use of funds than shares, you’ll probably prefer index funds. If people can’t make up their minds about what they need, they’ll probably go for the ETF as it gives them more options. We recently cut fees on our index fund range and our FTSE 100 index fund is now available for a fee of 25 basis points, compared to the 35 basis points we’re charging for the ETF on the same index.
My personal view is that traditional index funds are simpler than ETFs and should be cheaper as a result. For a long time, though, it’s been the other way around. For example, there was a BGI report a few months ago showing that the total expense ratio of index funds was, on average, double that of ETFs, so I’d say that index fund fees still need to come down and there’s scope for more disturbance in that market.
Eventually things will settle down and ETFs and index funds will be seen as part of a continuum of products, which should include index and single stock futures as well. As far as the relative pricing of these trackers is concerned, I think it’s fair to say that since ETFs are newer on the scene they’ve probably got their pricing and features right.
IU.eu: Will you be launching funds in other asset classes?
Thomas: Yes, we’ll be looking at fixed income and commodities, although our initial fund launches will be equity-focused. And, given our ambition to be the leading bank for Islamic services, we’ll be providing a range of Islamic ETFs as well.