Börsen-Zeitung: ETFs – Versatile and increasingly popular

17 Mar 2020

Börsen-Zeitung: ETFs – Versatile and increasingly popularHauke Stars, member of the Executive Board of Deutsche Börse AG

Titel: Hauke Stars, Mitglied des Vorstands, Deutsche Börse AG

Exchange Traded Funds (ETFs) have become mainstream. For a while now, it’s not only professional investors that have been using passive funds, but they have also reached the general public and are becoming increasingly popular. April 11th marks the 20th anniversary of the introduction of ETFs in Europe. Deutsche Börse was, and is, a pioneer with its Xetra trading platform.

The figures are quite impressive when it comes to savings and retirement provisions: investors in Germany have now established around 1.3 million ETF savings plans, as a survey conducted at the beginning of this year shows. This is an almost fourfold increase within three years.

This development is remarkable. It shows that more and more investors are aware of the effects of the ongoing zero-interest policy and of the statutory pension insurance in Germany, which is coming under increasing pressure due to demographic change. And they are taking a conscious decision in favour of the capital markets. With regard to asset accumulation and private wealth formation, only the capital markets with their higher long-term returns can offer a compatible solution.

ETFs are particularly suitable when starting to invest. These broadly diversified index funds on international benchmark indices are popular as entry-level products, as they can be understood without in-depth stock market knowledge and offer uncomplicated access to the capital markets. In addition, they offer low management fees and usually offer flexible saving starting from a monthly rate of 25 euros.

Despite increased awareness among investors, the question now remains as to why even more people are not saving via shares and funds, especially in comparison to other countries. Why are there “only” 1.3 million ETF savings plans? Three prejudices are characteristic of the low proportion of shares held by German investors, as a scientific study conducted by the Frankfurt School of Finance & Management, on behalf of Deutsche Börse, recently demonstrated. First, Germans think they have too little knowledge to engage in the capital markets. Second, they cite a lack of capital as preventing them becoming active on the stock market. And third, the fear of returns thwarts the calculation – those surveyed shied away from the supposedly high risk of financial markets.

It does not take a long chain of arguments to counter these prejudices, but rather only two simple, basic remarks: higher returns always go hand in hand with higher risk. And broad diversification and a long-term investment horizon significantly reduce risk. Over the last 50 years, investments in the DAX have generated an annual return of around 7 percent. And if that's not enough, the world's most important stock markets have achieved an average annual return of 5 percent since 1900 – even though crises, wars and inflation have at times caused severe setbacks.

But these impressive returns have done little to change Germans' shyness. Even major information campaigns by consumer protection agencies and the financial industry have had only limited effect. Nevertheless, we must not tire of explaining the advantages of long-term savings via the capital markets and strengthening general education in financial matters in Germany. The 20th anniversary of ETFs is an appropriate occasion to draw the attention of the general public to these issues.

However, ETFs are not only something for beginners. As a result of the growing trend towards passive investments over recent years, different types of investors use ETFs to replicate very different strategies. Whereas at the start of ETF trading in Europe in April 2000, there were just two products available to map the performance of companies in the EURO STOXX 50 and the STOXX Europe 50, 20 years later the product universe has grown to more than 1,500 index funds. With this selection and an average turnover of 11 billion euros per month, Deutsche Börse's Xetra trading platform continues to be the leader in Europe. Today, almost every region, sector and strategy can be represented via ETFs.

In recent years, supply and demand have risen sharply, particularly in the strategy area and in bond ETFs. The latter, in particular, allow much simpler investments than the underlying bonds themselves, in terms of maturities, denomination and liquidity.

The most recent trend is theme ETFs, which offer investors targeted access to megatrends such as ESG, robotics or cyber security. ESG products are among the fastest-growing categories: one-tenth of all tradable ETFs now focus on sustainability.

In order to maintain an overview of the ever more diversifying ETF market, and to improve the general education just discussed, Deutsche Börse offers investors a comprehensive and broad range of training and news. These include seminars and digital learning opportunities from our Capital Markets Academy, through to Certified ETF Specialists, webinars, newsletters and manuals. Börse Frankfurt’s investor portal offers extensive master data and trading data to support investors in product selection and order placement.

Deutsche Börse also supports investors with trading initiatives. Since last year, Deutsche Börse has, for example, waived transaction fees in Xetra trading for the execution of ETF Savings Plans and Robo Advisory orders. This way, we aim to further enhance the attractiveness of ETFs as a long-term investment product and attract additional private investors to the capital markets. The offer applies to all banks and brokers who register with us for this purpose.

Despite all the success of ETFs, there have also been repeated criticisms of these products. For a long time, for example, synthetic ETFs were viewed critically because they do not buy the actual underlying securities, but instead guarantee index tracking via a swap partner. Here, the fund providers have reacted to these criticisms and developed appropriate hedging mechanisms for synthetic ETFs. Nevertheless, the ongoing discussions have led to a situation where investors today often prefer physically replicating products.

Another currently much-discussed criticism of index funds relates to the market power of the products, especially in phases of market turbulence. If investors were to redeem ETF units, the respective providers would have to sell shares on a large scale, thereby exacerbating a downturn. At the same time, it is usually argued that active funds, on the other hand, could react in time because they do not track an index 1:1.

Let's be honest – even managers of actively managed funds cannot foresee a sudden fall in prices. They may even have to part with individual components of the fund portfolio as quickly as possible in order to have sufficient cash available for investors to redeem fund units. In fact, ETFs offer a significant advantage here. Since the products are also traded via a secondary market, sellers can sell their ETF directly to a buyer. While this may be associated with wider bid-ask spreads in turbulent times, it does not necessarily affect the ETF's fund portfolio.

This example illustrates the advantage of liquid exchange trading of ETFs. As a pioneer of ETFs in Europe, Xetra not only stands for highest liquidity and price quality, but also for proven protection mechanisms in stressful market phases. First and foremost, in this context, is the volatility interruption. Regardless of the market direction, this prevents large price jumps caused by, for example, incorrect order entries, illiquid market situations or the entry of unlimited orders with excessive transaction volumes. This is because if there are excessive price changes in a security, the system automatically switches from continuous trading on Xetra to an auction lasting at least two minutes. This decelerates trading, gives market participants time to orient themselves and prevents the market from moving unchecked in one direction.

Another major strength is that if a volatility interruption is triggered, the security concerned is not suspended from trading. This generally leads to even greater uncertainty among market participants and further increases volatility. This protective mechanism has proven itself many times over in 20 years and has created confidence among market participants.

Market participants' confidence in ETFs is high despite isolated critical voices. Assets under management in ETF trading on Xetra rose to a new record of EUR 710 billion at the end of 2019, an increase of 35 percent over the previous year. And analysts also have a lot of faith in the products for the coming years. According to a report by Morningstar, the market volume in Europe could rise to up to EUR 2 trillion by 2024.

The original German version of this article was first published in Börsen-Zeitung on 14 March 2020.