Generating alpha with ETFs

Deborah Fuhr Hello, this is Deborah Fuhr, managing partner of ETFGI, and this is ETF TV – a platform for insights on the use trading and product development trends impacting the ETF industry. Today we have Ciarán Fitzpatrick from State Street, managing director and head of Asset Servicing in Ireland, sharing his insights with us.

Dan Barnes Ciarán, welcome to ETF TV.

Ciarán Fitzpatrick Thanks for having me.

Dan Barnes So let’s start with, who’s winning the battle between passive and active management at the moment, do you think?

Ciarán Fitzpatrick Uh, I think it’s a difficult conversation. You will hear differences between people say, well, it’s passive over active. Yeah, I think a very good comment is achieving active through passive. I think the majority of ETFs in today’s market have some level of active strategy to them in their decision making going on from a portfolio manager. They’re building the indexes, so it’s not taking your standard market capitalization index and just fully replicating that. ETF issuers are actually producing and working directly  with the benchmark and index providers to build a custom index that they would like to replicate. So they’re looking at the niche that they currently operate in and really employing a transparent strategy, but there is an active nature to it. And, you know, I wouldn’t differentiate purely between active and passive, but I think there’s certainly an element of active in the majority of ETFs we’re seeing today.

Dan Barnes There’s always been active firms who are actually tracking the index anyways.

Ciarán Fitzpatrick It’s not it’s not a new thing. You know, it’s something that’s been going on for quite a while. And while there’s not your pure alpha-seeking ETFs with a lack of transparency from a regulatory standpoint, because it’s not approved even if it has recently been in the US to a certain degree. But I don’t think pure active products are ever going to dominate the ETF industry. It’ll obviously allow for managers who have active strategies today to continue to offer the strategies as they are, but with a wrapper, which is an ETF and offer them on exchange. But, you know, ultimately the transparency and I wouldn’t say it’s a pure passive nature, but the ETF product on the wrapper that it offers for an active manager is certainly something that would be attractive.

Dan Barnes That’s great, thank you very much. Whereabouts do you see innovation in the exchange traded product market?

Ciarán Fitzpatrick I see innovation being key for a number of components. From a State  Street global services perspective, we operate from a back office site for all of the ETF providers that we service. Yet we need to be innovative in the way we operate and the way we manage our clients and the way we service them and the business we offer them. We need to work with innovative technology firms and that’s very much something State Street is looking at today. I think you can see that through our acquisition of Charles River. You can’t just try and do it all internally. You need to engage external providers, your FinTech companies. And we’re seeing that if you look at the US ETF market, there’s a lot of smaller players and a lot of individuals and firms focused purely on ETFs. And you’re starting to see some of the FinTech companies coming in, in the UK and in Europe, et cetera. Will they be the ones that are 100% successful offering ETFs? Maybe not, but it’s the next level of that kind of firm, which I think from an innovation standpoint, will make a big difference.

And also, I think innovation is how you build your ETF. I think the concept of ESG is certainly starting to take off. And I think it’s still at this early stage. But a very interesting comment I heard off was that ESG will no longer be an issue in three to five years time, because the so-called sin stocks will no longer be represented in the index. So every single index being produced and attract different ETFs will actually have ESG. Whether that’s true or not, I don’t know. But I think the market, investors in general and large corporations are very much focusing on, what are the beliefs and what’s the strategy of the firm? And it’s not all about just achieving alpha. Some would prefer to not get such a large return, but hold a portfolio of assets and trade assets that are more in line with their beliefs as opposed to just purely looking for the return.

Dan Barnes And whereabouts do you see risk in the market today?

Ciarán Fitzpatrick You’ll see a lot of ETF issuers or newer issuers trying to do something that, you know, really pushing the ETF wrapper too far. You know, they’ll always say, you can really wrap anything in the wrapper. But if you start looking at private equity or property or anything like that, which are very illiquid assets, you’re offering a product which really sells itself on its liquidity and its transparency. It’s really only as liquid as its underlying components. If you start trading or offering ETFs, and there are some out there already which have an underlying quite iliquid, like the likes of bank loans, etc. are very illiquid products. If you offer them through an ETF strategy, you really haven’t got a very liquid product. So, you know, it’s a niche piece of the market that you don’t want have investors not knowing exactly what they’re buying into. So I think that’s one of the keys for an ETF. It’s got to be a transparent product or a product that investors can understand, and bringing in too much complexity really makes it a bit risky for the for the investors.

Dan Barnes That’s great. Ciarán, thank you very much.

Ciarán Fitzpatrick No problem, thanks. Thanks a lot.

Dan Barnes Thank you for watching ETF TV. To view our other shows, please go to ETFTV.NET, and follow us on LinkedIn and Twitter. Thank you.

Published on August 15, 2019