ETF trends and market comparison US and Europe

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1 ETF trends and market comparison US and Europe This document is directed at professional investors and should not be distributed to, or relied upon by retail investors. The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

2 ETF market trends US and Europe ETP Landscape Growth of passive Expansion of distribution channels Active ETFs Conclusion 2

3 Assets (US$bn) The US and Europe are the most mature ETP markets globally ETP growth comparison US and Europe $2,500 $2,000 US ETP assets Europe ETP assets All Other # US ETPS # Europe ETPs $2,785 Europe 10 year ETP CAGR: 35.2% US 10 year ETP CAGR: 26.9% $1,500 $1, # ETFs / ETPs $ $ Dec-14 Dec-14 M # US ETPs ,369 1,447 1,536 1,662 # Europe ETPs ,105 1,588 1,793 1,928 1,991 2,106 0 US ETP assets ,009 1,060 1,347 1,698 2,002 Europe ETP assets Source: ETFGI data as at 31 December Note: ETFs are typically open-end index funds that provide daily portfolio transparency, are listed and traded on exchanges like stocks on a secondary basis as well as utilising a unique creation and redemption process for primary transactions. ETPs refers to other products that have similarities to ETFs in the way they trade and settle but they do not use a mutual fund structure. The use of other structures including grantor trusts, partnerships, notes and depositary receipts by ETPs can create different tax and regulatory implications for investors when compared to ETFs which are funds. 3

4 Growth of passive 4

5 While the US has a heavier weight of passive, adoption in both markets has been steadily increasing US long-term mutual fund assets (billions) Europe long-term mutual fund assets (billions) $12,602 $13,892 $10,390 $5,333 $7,354 $8,736 $8,804 $4,209 $4,942 $4,653 $5,769 $6,964 $7,399 $2, Index LT 21% 21% 23% 24% 25% 27% 30% Index LT 9% 10% 11% 11% 11% 11% 12% Active LT 79% 79% 77% 76% 75% 73% 70% Active LT 91% 90% 89% 89% 89% 89% 88% Sources: Morningstar and Vanguard, as of December 31,

6 Recent US cashflow has overwhelmingly favoured passive products US long-term fund cash flows (billions) Europe long-term fund cash flows (billions) $522 $474 $489 $535 $438 $499 $414 $366 $400 $389 $61 $219 ($240) ($26) Index LT 100% 37% 46% 82% 57% 65% 88% Index LT 100% 21% 16% 100% 20% 11% 20% Active LT 0% 63% 54% 18% 43% 35% 12% Active LT 0% 79% 84% 0% 80% 89% 80% Sources: Morningstar and Vanguard, as of December 31,

7 Both markets share a relatively equal split in the vehicle chosen to access indexed investment US long-term index fund assets (billions) Europe long-term index fund assets (billions) $4,204 $787 $900 $3,436 $669 $1,574 $2,014 $2,124 $2,647 $434 $528 $513 $1,099 $ ETF 48% 50% 50% 50% 50% 49% 47% ETF 50% 53% 55% 55% 53% 51% 51% Index MF 52% 50% 50% 50% 50% 51% 53% Index MF 50% 47% 45% 45% 47% 49% 49% Source: Morningstar as of December 31,

8 However, index cashflow has favoured ETFs in recent history. US long-term index fund cash flows (billions) Europe long-term index fund cash flows (billions) $471 $317 $98 $267 $83 $75 $76 $210 $191 $190 $179 $64 $46 $ ETF 76% 62% 62% 63% 69% 57% 51% ETF 83% 63% 71% 73% 40% 31% 53% Index MF 24% 38% 38% 37% 31% 43% 49% Index MF 17% 37% 29% 27% 60% 69% 47% Source: Morningstar as of December 31,

9 Billions Billions While ETFs, comprise ~25% of cash equity trading, lack of uniform OTC reporting understates overall European ETF volume US ETP volume (USD) Europe ETP volume (USD) 1,000 ETFs now trading on the SIX Exchange $21,000 35% $1,000 10% 30% 9% $800 8% $14,000 25% 7% $7,000 20% 15% 10% ETF share $600 $400 6% 5% 4% 3% 5% $200 2% 1% $ % $ % ETF dollars Percentage of dollars traded ETF dollars ETF Dollars (SIX Swiss Exchange) Percentage of shares traded Percentage of shares traded (SIX Swiss Exchange) Source: Deutsche Bank, Arcavision, SIX Swiss Exchange, as / at December 31, SIX Swiss Exchange turnover includes ETFs only. 9

10 Expansion of ETF distribution 10

11 Local US ETFs Global asset managers continue to use US and UCITS platforms, but the European industry increasingly favours local products = primarily US platform = primarily UCITS platform = US & UCITS platform usage European listed ETPs experienced record cash flow of >$60 bn in 2014, nearly tripling 2013 s total. AUM Institutional investors in Mexico, Chile, Colombia, and Peru continued to purchase foreign listed ETPs 1 Japan is a large institutional holder of U.S. ETPs while Hong Kong, Singapore, and Taiwan utilize both U.S. and UCITS platforms Source: BlackRock, ETFGI, Broadridge, FactSet, Morningstar, Vanguard Analysis 11

12 ETF market penetration (by channel) Pattern of channel uptake It starts with institutions US and Canadian market today Global ex-us market today Europe and Asia Time Direct Adviser Institutional Less sophisticated individual investors as final adopters. Education and institutional adoption lead to recognition of ETFs benefits as low-cost diversification tool. More sophisticated early adopters create liquidity, reduce spreads, make ETFs more broadly attractive. Illustrative (not drawn to scale). Source: Analysis by The Vanguard Group, Inc. using data as at 31 December 2011 from The Vanguard Group, Inc., Bain & Co. and Investor Economics. 12

13 Competing Products Key Attributes Client Types Specifically, asset managers & wealth managers are the primary users of ETFs in Europe, but retail penetration is gaining pace... Institutional Retail Pension Funds Asset Managers IFAs Estimated AUM concentration Corporates Insurance (BS 1 ) Hedge Funds Private Banks - discretionary Private Banks - advisory Insurance (UL 1 ) Self-direct Price Benchmarks Reporting Fund size Liquidity Tracking Tax Exposures SMAs Delta-one products 2 Mutual Funds Note: 1. BS: Balance Sheet / UL: Unit Link; 2. Delta-one products: Swaps, Futures, Notes 13

14 A fee and regulatory (r)evolution around the globe Source: Illustration by The Vanguard Group, Inc. 14

15 Global fund distribution reform Fund distribution reform: Inducements SEC adopts rule 12b 1 introducing the concept of the noload fund Commissions on pensions banned Effective 2008 Retail Distribution Review Effective 1 January 2013 Future of financial advice Effective 1 July 2013 Self-imposed ban on inducements Effective 1 January 2014 European Distribution Reform Effective 3 January 2017 Requests comments on retail compensation structures Financial Advisory Industry Review Market intended not yet effective Proposed inducements ban for advisers to nonprofessional clients if not in client s best interest 15

16 Where the revolution s going Percentage of fee-based compensation around the world 100% 100% 100% 80% 66% 60% 55% 40% 35% 25% 20% 15% 10% 0% U.S. Australia Canada U.K Source: Illustration by The Vanguard Group, Inc. using data as at December 31, 2011 and December 31, 2014, from The Vanguard Group, Inc. and Cerulli (U.S., U.K. and Australia) and Investor Economics (Canada). 16

17 Although evolving, European ETFs are still primarily an institutional product From institutions to advisors Institutional Advisor Direct U.S. 51% 45% 4% Canada 39% 39% 22% U.K. 80% 15% 5% Continental Europe 85% 10% 5% Asia 90% 9% 1% Australia 10% 55% 35% Source: Analysis by The Vanguard Group, Inc. using data as at June 30, 2012, from The Vanguard Group, Inc., Bain & Co. and Investor Economics. UK / Continental Europe Institutional classification includes Wealth Managers. 17

18 Emerging markets of ETF distribution Evolving usage US Alternative investment vehicles Separately managed accounts Variable annuities Structured notes 401(k) plans 529 plans Direct retail - Fund of funds, Life cycle/target retirement Robo-advisors Model portfolios Europe Financial adviser market Direct retail - Fund-of-funds / multiasset allocation Pension Insurance Discretionary Fund Managers Model portfolios Robo-advisors Model portfolios 18

19 The reduction in cost of ETF investing will continue to be a key driver for growth 0.59% 0.41% 0.16% 0.13% Vanguard Simple Avg. expense ratio (Europe) Simple average expense ratio (Europe) Vanguard simple average expense ratio (US) Simple average expense ratio (US) Sources: MorningstarDirect Vanguard analysis, company websites, and Morningstar, as of December 31, Morningstar data 2014 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. 19

20 Future growth prospects for active ETFs 20

21 The evolution of indexing U.S. equities Non-U.S. equities Benchmarking Active/passive debate Market capitalization L V B G M S U.S. bonds Non-U.S. bonds Different beta exposures Core-satellite 21

22 Indexing has reached a tipping point Acceptance of indexing has given way to a proliferation of benchmarks, products, and alternative index strategies 22

23 Active ETFs in the form of smart beta are not new Active stock selection Should an investor focus on some factors? Assets Cash-flow Book value Sales GDP Landmass Population Energy consumption Or do other factors matter as well? Political risk (willingness) Inflation Exchange-rate policy Externally-held debt Composition of economy Capital flows Liquidity Demographics Profits Competitive landscape Management effectiveness Corporate governance controls Expected growth New products/lines/business Regulatory environment Accounting shenanigans Off balance sheet items International operations Forward-looking expectations Leverage Counterparty exposure Supply chains Natural disasters Any factor used market participants Market capitalization captures all potential factors that all investors collectively use to determine a stocks price Source: Vanguard. 23

24 Number of ETFs $ Billions Despite product proliferation, adoption of active ETFs in the US has been modest U.S. ETF product growth 2,000 1,800 1,600 1,400 U.S. ETF net cash flow $200 $150 1,200 1,000 $ $50 $0 Actively managed Rules based security selection-rules based weighting Rules based security selection-cap. weighting Passive security selection-rules based weighting Passive security selection-cap. weighting -$ Source: Morningstar Direct and Vanguard analysis. Passive security selection means replicates a financial market or sector of that market. Rules-based security selection means filters out securities from a particular market segment or relies on mathematical models to choose securities. Capitalization weighting bases the allocation on the relative market value of each security in the index. Rules-based weighting means assigns a set weight to each security in an index or to each industry in an index or utilizes qualitative factors and/or financial information to allocate securities. Actively managed means active security selection and active management in a full transparent portfolio. 24

25 Assets Characteristics of open and closed ETFs in the US: Assets and tenure Tenure (years) $100,000M $10,000M $1,000M $100M $10M $1M ETFs 10 that 11 failed to 12 capture $30 million AUM in 3 years Open Closed 67.4% closed ETFs (263/390) 17.0% open US ETFs (247/1,451) Source: Bloomberg and Vanguard calculations, as of December 31,

26 Conclusion European ETF growth is being driven by a number of factors that are similar to those witnessed in the US ETF market. The Europe ETF market is currently growing at a faster pace than the US. Adoption in passive management has accelerated in recent history, with ETFs increasingly becoming the vehicle chosen to access passive management Regulation is focusing on costs and driving a broader range of products for intermediaries to select from. European-domiciled UCITS are increasingly becoming the product-of-choice for ex-us investors, particularly in Europe, South America, and Asia. Increased focus on reducing the cost of investment by the industry will be key for sustainable ETF growth. Product development will shift towards product solutions, but meaningful innovation will be mixed with meaningless proliferation, resulting in proliferation and closures. Although attention to actively managed ETFs has heightened recently, active products have been launched in the market for a number of years in the form of smart beta and enhanced indexing. Despite slow growth, active ETFs could provide low-cost actively managed strategies to the masses. 26

27 Growth of $100 invested in index average versus Total Stock Market Index fund Appendix: The benefits of hindsight 87% of new indexes outperformed the broader market in back-tested results on an annualised basis Only 49% outperform the broader market after inception 300 Annualised excess return before inception: 12.5% Annualised excess return after inception: -0.3% count of Indexes Event Study - Index Incpetion date Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index. 27

28 Important information This document is directed at professional investors and should not be distributed to, or relied upon by retail investors. The opinions expressed in this presentation are those of individual speakers and may not be representative of Vanguard Investments Switzerland GmbH. The material contained in this document is not to be regarded as an offer to buy or sell or the solicitation of any offer to buy or sell securities in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so. The information on this document does not constitute legal, tax, or investment advice. You must not, therefore, rely on the content of this document when making any investment decisions. Past performance is not a reliable indicator of future results. The performance data does not take account of the commissions and costs incurred in the issue and redemption of shares. ETF shares can be bought or sold only through a broker. Investing in ETFs entails stockbroker commission and a bid- offer spread which should be considered fully before investing. Issued by Vanguard Investments Switzerland GmbH Vanguard Investments Switzerland GmbH. All rights reserved. VAM

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