Rethinking European ETFs: Strategy wrappers and a means to an end

As central banks move to combat inflation, a long era of low interest rates that helped drive ETF growth in Europe and the U.S. may be finally coming to a close. As market dynamics change, learn how clients are redefining the function of ETFs and finding flexible, innovative ways of using them to protect their portfolios and realize new goals.

The European market has seen steady growth in exchange-traded funds (ETFs) for nearly two decades. From 2005 through 2020, ETF assets under management (AUM) “increased by more than twentyfold.” And in 2021, total AUM in Europe passed the 1.2 trillion euro milestone.

This growth coincides with a long period of low interest rates and sustained quantitative easing. Although numerous other factors have played a role, it’s indisputable that the backdrop is changing. As we observe the aftereffects of COVID-19, we can already see inflation trending upward and interest rates creeping higher in response.

For much of the past two decades, an ETF was generally viewed as an end in itself – as a retail investment, index tracking product and easy way to gain exposure to an index to equitize cash. Now, with interest rates on the rise, managers are getting more inventive with how they use this type of securities basket.

As one of the largest ETF servicers in the United States, our team at U.S. Bank has gained valuable insight from our clients over the years. New dynamics in the market are leading many of those clients to consider European launches, and we’ve broadened our understanding even further as we expanded our comprehensive ETF solutions into Europe to support them.

In this article, we’ll offer key observations from two of our chief ETF experts: Tony O’Brien, business and product development specialist at U.S. Bank, and Alan Doyle, global head of product and strategy for U.S. Bank. Learn how the function of ETFs is evolving and how you can leverage them to take advantage of untapped distribution opportunities both in Europe and beyond.

Read more: What are exchange-traded funds?

A shift toward specialized firms and sectoral exposure

Most of the first ETFs in Europe were launched in the early 2000s by major market participants – heavyweight banks and international asset managers (e.g., Barclays (BGI), Merrill Lynch, Deutsch Bank, UBS, etc.)

Over time, a variety of smaller players started entering the space. Fund launches by specialized, entrepreneurial firms heralded a shift away from large-scale interplay in favor of ETFs focused first on sub-sets of the major market indices and then on sectoral exposure. Smart beta products added a performance dimension to try to capture and enhance the upside in seemingly ever-climbing equity indices. The trend has continued in that direction, especially as those smaller firms grew, merged and consolidated.

“Now we’re to a point,” says O’Brien, “where the success and predominance of those highly focused firms has drawn the attention of new players – both in the EU and the U.S. – who want to get in on the action and launch European ETFs of their own.”

Read more: Learn how authorized participants help facilitate ETF creation and redemption.

Prioritizing flexibility

For almost this entire period, global interest rates sat at incredibly low levels. This climate underpinned the growth of private equity and private markets as asset managers sought to add these higher-risk-and-higher-yield strategies to their arsenal. Now, we’re in a position where that could all change. Central banks seem poised to pull back from quantitative easing, and interest rates could start to rise to offset inflation in various parts of the world.

“We’re starting to see a shift, a very slow U-turn away from the chase for yield, which really defined the last 10 years or so, toward more flexible solutions,” says Doyle.

And ETFs are the ideal product to support this change in priority.

ETFs as wrappers

ETFs have typically been viewed as retail products used to access indexes. Now, they’ve taken on new life as strategy wrappers – no longer an end in itself, but a means to an end.

“There is a significant trend in clients wrapping ETFs around their strategies, whatever those strategies might be,” says O’Brien. “And because of that, we’re seeing people talk about ETFs in much more flexible terms.”

The shift opens new avenues of innovation and accommodates a more entrepreneurial mindset.

“We’ve drifted away from ETFs as a pure exposure play, and we’re seeing more of them based on active strategies,” O’Brien continues. “It gets even more interesting when managers use this approach to take advantage of something happening in the market – like cannabis-based ETFs, ESG-focused products, Bitcoin-based ETFs or even ETFs targeting stocks likely to benefit from higher rates of inflation.”

It’s also causing many U.S. asset managers to look to Europe for fresh new opportunities.

“We’ve been very tuned in to what our clients are telling us,” says Doyle. “They’re talking about active strategies. They’re talking about ETFs as wrappers, of course. But they’re also talking about protecting against inflation, and accessing untapped opportunities in Europe, and using ETFs to help them realize the new goals they’re still in the process of putting together.”

Unique European pain points

Entering the European market introduces its own distinct set of obstacles. One of the stickiest pain points clients encounter is that Europe’s large number of stock exchanges creates a highly fractured settlement infrastructure.

“There’s a very broad ETF ecosystem here that can be daunting for new entrants,” says O’Brien. “It’s comforting, then, to have absolute confidence in your service provider – knowing they’re plugged into that ecosystem, they’ll navigate you through it, they’ll introduce you to all of the main players and enable you to stay focused on what it is you’re good at.”

Having a comprehensive, end-to-end service provider also helps new entrants in this regard. It gives them a single relationship to manage instead of forcing them to ink numerous contracts and coordinate with multiple, disconnected firms.

“We want to make it as easy as possible for issuers to get into the European market,” says Doyle. “We don’t want them to have to concern themselves with the mechanics. We want them to stay focused on the important things happening in the markets and with inflation at the moment, and we’ll take care of the plumbing.”

The importance of the right partner

At U.S. Bank, we’re committed to supporting the ETF community through our expanding resources and presence around the globe. Our one-stop-shop model combines end-to-end services into a seamless, multi-domicile solution – consistent, efficient and transparent across Europe and the U.S.

“This broadening awareness of what you can do with an ETF matches perfectly with our full-spectrum support strategy at U.S. Bank,” says Doyle. “We’ve built out our infrastructure to accommodate smaller asset managers who want to come over to or are already active in Europe, as well as more established asset managers in that middle market space both from and ETF and a UCITS perspective.”

Our model helps clients avoid the complexity of coordinating multiple providers for European-domiciled ETFs. Instead, we’re able to provide fund administration, transfer agency, custody, common depositary services and more – all under one roof.

Read more: Explore the role custodians play in keeping ETFs secure.

Read more: What are depositary services?

“With operations in the U.S. and Europe, we’re effectively able to function on your behalf as a single team across two jurisdictions,” Doyle continues. “We have the infrastructure to seamlessly move data around through our fund accounting and transfer agency systems – into the United States to capture the market close, and back again before European markets open.”

Looking to the future: An ongoing need for innovation

Innovation has always been a foundational element for ETFs. The most successful partnerships are ones that generate new ideas, ones that take existing concepts and find creative ways to apply them.

“Those who have been most successful at servicing ETFs aren’t necessarily the order takers,” says O’Brien. “Instead, it’s the ones who share interesting perspectives and build on ideas. It’s the ones who offer their clients insight based on what other people are doing and what they’re learning in other conversations.”

And as the landscape continues to evolve, this type of innovation will become more important than ever.

“When I look across our client base in the U.S., that sense of innovation is evident in the diversity of the strategies that we’re seeing,” O’Brien continues. “When I have conversations with our team, there’s really nothing they haven’t seen or can’t accommodate. This ability to add to your client’s more entrepreneurial or innovative instincts, it’s very hard to put your finger on it. But when you hit that sweet spot, it’s like striking gold. It really, really makes a difference.”

Whether you’re a large, established firm, or a specialized shop looking to take your business to the next level, we have a full spectrum of ETF servicing solutions to help accelerate your success. To learn more, visit usbank.com/globalfundservices or check out these other resources:

• What are exchange-traded funds? 
• Understanding the role of authorized participants in exchange-traded funds 
• The unsung heroes of exchange-traded funds 
• Depositary services: a brief overview 
• Emerging trends in Europe: An outlook from multiple perspectives