The ongoing Trend to Passive Investments and Two related Investment Ideas

I recently started my first monthly ETF savings plan (finally!) in January 2020 and it appears that I was rather late compared to millions of other ETF investors. Since more and more private investors are using ETFs as a cheap, effective and very diversified solution to capture broad equity* exposure globally, I wanted to research some investment ideas reaping benefits from this ongoing trend.

This is not investment advice. Please read the disclaimer.

*) There are institutional investors besides private ones and there are other asset classes than equity. Anyway, explanations about ETFs and examples are mostly related to equities.

Exchange Traded Funds or ETFs are funds that are tradable on exchanges and priced intraday (like stocks) tracking an index the benchmark, i.e. the S&P 500 in the US or the DAX 30 in Germany. Equity ETFs offer exposure to broad/diversified equity markets. Costs involved are commission fees for buying/trading the product (similar to buying stocks) and (annual) management fees (opposed to stocks). However, the management fees for ETFs / passive products are much lower than for traditional mutual funds. Additionally, most fund managers do not outperform their benchmarks (before/after costs).

(Commission fees are also coming way down, sometimes lowered to zero. As a reference, I started to buy an iShares product via TradeRepculic like written here and they charge zero execution fees for ETF saving plans)

Assets Under Management

The above advantages lead investors to prefer ETFs to traditional (index) mutual funds. Below are some facts regarding the “Big Picture”

  • Passive equity Assets under management or AuM in the US rose much stronger since 2008 than active AuM.
  • Half of measured equities under management in the US are now und passive management, up from 10% in 2003. The development for Rest of World shows a similar trends with 35% in 2019 up from 5%.

Fees

There is an ETF fee war raging with ever lower fees for passive products. Especially vanially ETFs or core products simply tracking a broad index like the S&P 500 are offered as cheap as 0.05% annually by the big payers, namely BlackRock (iShares) and Vanguard.

etf.com

Asset managers try to sell more advanced passive products based on so called factors (value, momentum, quality, growth, …). Blackrocks offers Edge products and in general these products are marketed as smart beta (beta is another factor related to CAPM). These products allow asset managers to charge higher fees for now.

The trend towards lower management fees is also in place in the fixed income asset class (more important for institutional investors).

bloomberg.com

Company #1: Blackrock

BlackRock is a global investment manager and our purpose is to help more and more people experience financial well-being. As a fiduciary to investors and a leading provider of financial technology, our clients turn to us for the solutions they need when planning for their most important goals.

ir.blackrock.com
  • One of the mayor players within the Asset Management Industry
    • Vanguard being another mayor player
  • Market Cap: 87 bn USD
  • Valuation: P/E of c. 20x, shares @ $656 (up from 400 in Dec 2019)
  • Growth: Assets Under Management of $7.43 trn at December 31, 2019
    • up from AuM of 5.15 trn in 2016
    • $1 trillion of net inflows from 2014 to 2018
  • Drivers: AuM Growth, average management fee, growth in services revenue
    • AuM growth is likely to provide a strong tailwind in the long-term through net fund inflows with short-term fluctuations caused by capital market returns (price fluctuations)
    • in the investment management industry it should be an advantage to be one of the biggest player (AuM) since technology and other fixed costs can be spread to a larger asset base. This should be especially true for ETF/passive investment and during the ETF fee wars. Additionally it enables better/more data insights being useful for other services (i.e. Aladdin: see below)
    • Average Management fees could be pressured a bit further, but
      • Institutional fees are already very low, so pressure is rahter limited to retail solutions / iShares
      • Illiquid alternatives provide higher management fees and strong growth trends
      • Factor investing also captures higher fees
    • Technology services revenue
      • Aladdin and BlackRock’s digital wealth technologies
      • representing 7% of total revenue in 2019
      • Up 24% from $785 mn in 2018

Company #2: Flow Traders

Flow Traders is a leading global technology-enabled liquidity provider, specialized in Exchange Traded Products (ETPs). We are able to grow our organization further, thereby ensuring that our trading desks in Europe, the Americas and Asia provide liquidity across all major exchanges, globally, 24 hours a day. Founded in 2004, we continue to cultivate the entrepreneurial, innovative and team-oriented culture that has been with us since the beginning.

flowtraders.com/about-us

Flow Traders Annual Report 2019 will be released on Feb 28.

  • Industry: Principal Trading
  • Market Cap: 913 mn EUR with a Share Price of € 19 down from 50 in early 2016 and down from 40 in early 2018
  • Valuation: P/E of c. 17x
  • Growth: Net trading Income (NTI) is quite volatile
    • 216.4 mn€ in 2019 down from 383.4 in 2018, driven through
    • long term ETP market growth and
    • market trading activity (increases with volatility)
  • Drivers are manyfold:
    • ETP traded, with growth mainly from Americas & Asia
      • Global trends to passive ETFs/ETPs: AuM
      • Market Shares Americas/Europe/Asia
    • Market Data such as Price and Volatility
    • Operations
      • expanding tradeable products
      • nextwork/counterparties
      • technology/people

Summary

  • I believe the trend to passive investing will continue for many years.
  • As a direct investment in the described trends Blackrock could benefit from its sheer size of Assets under Management, better data insights, and better technology; eventually surviving as one of a few global mega asset managers
    • total return limited based on market captalization of 87 bn$
    • rather smooth strong underlying long-term trends/drivers
  • As a much smaller and younger company Flow Traders constitutes an indirect investment in the growing passive investment industry as it provides liquidity.
    • nich player with low market capitalization of c. 1 bn$
    • profits are much more volatile
    • risk of not winning the game / inensifying competition

Outlook

I hoped you enjoyed this blog post about trends towards passive investing. I would be happy about reading some feedback regarding your experiences with passive investments or about some general feedback 🙂 Please feel free to comment below!

I plan to to write follow-up posts about BlackRock and Flow Traders.
Best, s4v

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