Fund Management

Index-Tracker Funds Prosper But For How Much Longer?

Tom Burroughes, Group Editor, 15 August 2018

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Exchange traded funds and products have surged on the back of a bull market, and continued to prosper in July.

Rising equity markets in July helped boost assets invested in exchange traded funds and products, but the recent Turkey-related turmoil could cut inflows for August.

Data from ETFGI, a consultancy and research business, said that assets invested in ETFs and ETPs listed globally reached a new high of $5.12 trillion, following net inflows of $41.13 billion in July. This marks the largest monthly net inflows since January when the global market for such structures logged net inflows of $105.73 billion.

“Investors favoured equities over fixed income and commodities as equity markets have performed positively in July. The S&P 500 gained 3.72 per cent, international markets ex US were up 1.93 per cent and emerging markets up 2.81 per cent,” Deborah Fuhr, managing partner and founder of ETFGI, said.

She added, however, that investors are still concerned about the impact of trade wars and Brexit.

At the end of July 2018, the Global ETF/ETP industry had 7,487 ETFs/ETPs, with 14,427 listings, assets of $5.12 trillion, from 375 providers listed on 70 exchanges in 57 countries. The ETF and related market has boomed in recent years, as their low-cost, index-tracking approach has benefited from a rally in global equities since the end of the 2008 financial crash, causing a squeeze to actively-managed portfolio firms. ETFs are typically open-ended, index-based funds, with active ETFs accounting for 1.1 per cent of the market share. ETPs, on the other hand, are alike ETFs in the way in which they trade and settle, but do not use an open-end fund structure.

By way of comparison, the MSCI World Index of developed countries’ equities shows total returns this year (capital plus reinvested dividends, measured in dollars) of just 2.42 per cent (data as of Aug 13). The MSCI Emerging Market Index shows a loss of 8.4 per cent since the start of 2018.

Turkey fright
The ETF/ETP data came out around the same time that markets were slammed by worries of financial implosion in Turkey, which is at odds with the US. Turkey’s lira has slumped this year against major currencies such as the euro and dollar; the slide accelerated in recent days. The saga has raised concerns about the vulnerability of other emerging market economies in Asia and Africa.

Said Haidar, founder and chief investment officer of Haidar Capital Management, a US investment house, said: “So far we have seen contagion into EM particularly CEEMEA such as Poland and Hungary, as well as into peripheral European bond and equity markets. This has exacerbated concerns already in the market about Italian fiscal plans. Italy has large trade exposure to Turkey, while both Italy and Spain have large banks with significant exposure to the Turkish banking sector.”

“Developed markets have held up better but we are seeing some level of concern with regards to European assets including the EUR [euro] and European banks,” he added.

Nicholas Brooks, Head of Economic & Investment Research at Intermediate Capital Group, said that the Turkish economic position will deteriorate further and was scathing about the policy stance of Turkey’s president, Recep Tayyip Erdoğan.

“The situation in Turkey is likely to get worse before it gets better. The fundamental problem in Turkey has been the build-up of unsustainable economic imbalances (current account deficit 6.3 per cent of GDP, corporate foreign currency debt 35 per cent of GDP, inflation rate of 16 per cent), while the economy is now in a vicious downward spiral with the fall in the lira leading to concerns about corporate and financial sector solvency, further pushing down the currency and increasing capital outflows,” Brooks said.

“Only a sharp hike in interest rates to halt capital outflows and incentivise inflows will halt the downward spiral. Capital controls, if implemented, will not be effective as Turkey needs foreign capital inflows to fund its current account deficit and to re-finance large foreign currency borrowing coming due this year. Investors will not bring new funds into the country if they don’t believe they will be able to get it back out,” he continued.

“President Erdogan has made keeping rates low a key plank of his political platform, describing interest rates as the `mother and father of all evil’ and arguing that higher interest rates are the cause of high inflation. This stands economic orthodoxy on its head and has been the equivalent to investors as waving a red cape in front of a bull,” he added.

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