Deutsche denies physical ETF rollout is due to flows

Deutsche Bank’s Marco Montanari has denied its move to roll out a suite of physically backed ETFs alongside synthetic funds is driven solely by money flows, saying it aims to provide a supermarket selection for clients to choose from.

“The ETF market is still very young and we are trying to match client demand,” says Montanari, Asia head of ETF unit db X-trackers. “The best is yet to come for the whole ETF market.”

To date db X-trackers has dealt solely in ETFs tracking underlying indices via swaps, in a process known as synthetic replication. That contrasts with ETFs which physically hold the stocks of the indices they track.

In total db X-trackers has 246 ETFs globally, of which 236 have been launched in Ucits format via its European platform. Of these, 30 are cross-listed in Hong Kong and 47 in Singapore.

But synthetic replication has proved controversial owing to the potential for counterparty risk, and in September last year tighter collateral rules were introduced, making them potentially trickier and more costly to manage. (See AsianInvestor magazine, October 2011, pages 34-35.)

And yesterday db X-trackers announced that from December it would offer physical replication on six developed market benchmarks: Germany’s Dax, the S&P500, Euro Stoxx 50, FTSE 100, Nikkei 225 and Euro Stoxx 50 (ex-financials).

Initially it will list these funds in London, Frankfurt and Milan, with further listings set for next year including potential cross-listings in Asia, subject to regulatory approvals.

But European flows tell a story. Synthetic ETFs have seen €477 million in inflows to date this year, compared with €2.4 billion for physical products. That compares with last year, when synthetics suffered -€3.5 billion in net outflows, while the physical side enjoyed €18.7 billion in inflows. Physically backed products now make up 63.3% of Europe’s ETF market.

Further, db X-trackers itself has seen a net $200 million in outflows this year, and that follows a $334 million outflow last year, reports the Financial Times.

However, Montanari argues it is too simplistic to say Deutsche is simply responding to asset flow dynamics by launching physical ETFs. “It is difficult to draw conclusions from inflows or outflows which may relate to other factors as well and not just the structure,” he says.

He points to the success in 2008 of db X-trackers synthetic money-market ETF, which linked to the reference overnight rate in the eurozone and proved popular as investors sought to avoid duration risk and liked the quality of the collateral. He notes, too, that the most successful ETF in Hong Kong in terms of volumes is a synthetic one (iShares FTSE A50 China Index ETF).

However, he concedes: “Having said that we recognise that there is a demand for physical ETFs and we want to meet this demand.”

But Montanari confirms the plan is not to replace its existing synthetic suite with physically backed ones, rather to have them run in parallel so that investors can choose.

“We still believe synthetics are very efficient both in terms of tracking error and cost efficiency,” he notes. “But it is a fact that some investors have shown a preference for physical replication lately, so we want to offer them the best of both worlds and to complete our product range.”

Deutsche Bank has always argued that synthetic ETFs generate low tracking error compared with physically backed products, and stressed that its suite is 100% collateralised on a daily basis and can be viewed online.

Looking ahead, Montanari notes there may be a slight difference in cost between its synthetic and physical ETFs, given that it is generally cheaper to run a synthetic structure.

The Euro Stoxx 50, for example, is offered at zero on the synthetic side, but will cost 15 basis points on the physical, he notes. “But it is all very transparent,” he adds.

He confirms db X-trackers will launch additional physical ETFs in Europe next year, although it is still considering which ones to tackle first from a structuring perspective. “Some indices linked to developed markets are easier to replicate physically,” he states.

“Others linked to emerging markets may require further analysis to ensure the tracking error is efficient. We want to make sure the products are structured in a robust way to make sure we don’t jeopardise our platform.”

Moreover, Montanari says db X-trackers will list more synthetic ETFs where it sees fit. “If there are markets that are missing in our synthetic range, we will consider adding to it,” he states.

“This is really about having a supermarket for synthetic ETFs and for physical ETFs. Investors have an evolving attitude and we try to satisfy what they want by giving them the largest possible product range.”

Additionally, Montanari denied the move to launch a suite of physical ETFs was linked to Deutsche Bank’s decision to shift db X-trackers from its investment bank to its retail fund management arm DWS (it now comes under the Asset Wealth Management division).

“The creation of physical ETFs has been planned for several months now in order to ensure the robustness of the new physical structures,” he notes.

Separately, also in December Lyxor Asset Management is set to convert four ETFs based on the EuroMTS Macro Weighted AAA Government Index Series from synthetic to physical replication "to fully address investors' needs", according to a statement from the firm.