Does the long-established US fee-based advice environment portend a coming surge of ETFs/ passive funds in Europe under MiFID II? Europe s ETF Future

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1 Eurpe s ETF Future Des the lng-established US fee-based advice envirnment prtend a cming surge f ETFs/ passive funds in Eurpe under MiFID II? December 2015

2 Table f Cntents Eurpe s ETF Future Areas f Fcus Pages Summary 3 Equity: The US leads Eurpe twards ETFs 4 6 Changing Incentives 7 Current Active Opprtunities 8 Assets: Active r Passive? 9 Flws: Islated Passive Vehicles Pint f Entry 12 Peridic Tables f Wrldwide Fund Flws Nte & Cntact

3 Summary Eurpe s ETF Future 1. Tw key drivers dictate the shrt-run dynamics between investment managers and distributrs as it relates t engaging end-investrs: balance f fees earned and ultimate cntrl f endinvestr relatinships. 2. The lng-established incentive structures in Eurpe t distribute full fee building blck mutual funds centered n prduct retrcessins are disslving. While taking place at varying rates acrss the glbe, the directin is clear fees are headed dwn. 3. Basic market access, nce nly available thrugh actively managed full fee building blck funds, is nw cheap and ubiquitus thrugh passive mutual funds and ETFs. 4. If prduct trends in the U.S. are any indicatin f what Eurpe shuld expect in an advice fr fee envirnment, the shift frm active building blck mutual funds t passive funds and ETFs is set t explde in adptin. 5. The U.S. wealth management industry, driven by market frces, shifted frm prduct dependent transactin t fee-based advice cmpensatin mdels beginning 15 years ag. In Eurpe regulatrs frced the change in a fractin f the time the impact n traditinal asset managers is just beginning t be felt. 6. Investment managers must find ways t differentiate themselves and repsitin their value t distributrs. Building blck funds will nt suffice int the next decade. Exceptinal specialist strategies ffering rbust alpha, liquid alternatives and multi-asset slutins are the way frward fr active managers. 3.

4 Equity by regin US has led the march twards ETFs Eurpe s ETF Future 125% Equity Assets as f 2015 Q3 125% Equity Flws since % 100% 75% 75% 50% 25% ETF MF - Passive MF - Active 50% 25% ETF MF - Passive MF - Active 0% 0% -25% Eurpe Wrldwide United States -25% Eurpe Wrldwide United States US actively managed equity mutual funds currently make up 61.2% f the ttal US equity mutual fund & ETF universe by assets ($8.6 trillin). Eurpean actively managed mutual funds make up a larger prtin (77.7%) f the smaller Eurpean equity mutual fund universe by assets ($2.6 trillin - a third the size f the US equity market). The United States has led the way in ETF adptin. ETFs have accunted fr 73.5% ($978.1 billin) f the $1.3 trillin in US equity flws since 2007 (separate accunts excluded). Eurpean equity ETFs accunt fr 42.1% ($164.8 billin) f the $391.7 billin in Eurpean flws in the same perid. Actively managed equity prducts have accunted fr 24.9% f ttal equity net flws since 2007 in Eurpe, -3.2% Wrldwide and -21.6% in the US. The US has a higher prtin f their assets in ETFs than Eurpe des, but is this driven by a fundamental difference between the regins r is the US a leading indicatr? It s the latter. 4 Data Surce: Mrningstar Direct. Analysis: Prpinquity Advisrs 2015 Prpinquity Advisrs LLC

5 The six year lag Eurpe s ETF Future Equity ETF Assets as a Percentage f Ttal Equity Mutual Fund & ETF Assets Percentage Year in Eurpe % 20% 15% 10% 5% 0% Year in the United States United States Eurpe Over the past 17 years the percentage f ttal cmbined equity mutual fund & ETF assets that are ETFs in the United States has grwn steadily (apprximately 1% per year) frm 0.7% in 1998 t 17.7% tday. When the Eurpean percentage f mutual fund & ETF assets in the glbal brad categry equity ETFs is graphed with a six-year lag the trends align. Eurpe s adptin rate in 2015 parallels that f the United States in What is the value f advice? hw end-investrs end up paying fr it determines fee distributin. Fee fr advice mdels drive dwn fees fr underlying building blcks. 5 Data Surce: Mrningstar Direct. Analysis: Prpinquity Advisrs 2015 Prpinquity Advisrs LLC

6 The eight year lag Eurpe s ETF Future Active Mutual Fund Equity Assets as a Percentage f Ttal Equity Mutual Fund & ETF Assets Percentage Year in Eurpe % 85% 75% 65% 55% 45% Year in the United States United States Eurpe 6 An even strnger relatinship ccurs cmparing active mutual fund equity assets as a percentage f ttal mutual fund & ETF equity assets. Eurpe is perating n an eight year lag. If the United States is used as the leading indicatr, Eurpe s future active equity mutual funds will make up less than 70% f ttal equity mutual fund & ETF assets by the beginning f 2020 (dwn frm 77.7% tday). This trend is driven by ecnmic incentive structures if yu want t knw what distributrs are inclined t d, take a lk at hw they are paid. With full transparency t ttal fees paid, end-clients will cntinue t demand cheaper prducts. There is increasing incentive fr distributrs t ffer mre services and t charge higher fees fr the advice in a bundled envirnment while paying less fr the underlying building blcks f investr prtflis. But nly t a pint Data Surce: Mrningstar Direct. Analysis: Prpinquity Advisrs 2015 Prpinquity Advisrs LLC

7 An evlving fee regimen Eurpe s ETF Future Transactin Based US psitin in early 2000s US psitin ~ 2008 Fee Based US psitin tday Asia-Pacific Eurpe & Canada United States Incentive structures dictate cmmercial relatinships between investment managers and distributrs. Relatinships between these tw entities are n lnger as clear and singularly aligned as they were pre Since the disruptin t retrcessin-lgic (brught n by the free market in the US and regulatin in Eurpe) the cmmercial incentive structure has changed. Distributrs are rethinking their business mdels t reflect the shift frm bth transactin-based sales and prduct-derived retrcessins. The US market is nw largely driven by a fee-based envirnment. As Eurpe is nw experiencing with the cleansing f share classes, share classes fr active funds in the US have expanded t reflect demand fr institutinal share classes. Demand fr lad (sales charge) funds has fallen ff a cliff. Still largely transactin-based, Asia-Pacific as a whle is apprximately 10 years behind this transitin regulatry changes have a remarkable way f speeding up the clck. Cmmercial and investment decisins are mre bund than ever. The cntempraneus investment challenges t active management thrugh the bull market have added t the pressure n active funds % f wrldwide net flws int equity since 2007 have been twards ETFs and passive mutual funds as ppsed t -3.2% int active mutual funds. 7 Data Surce: Mrningstar Direct. Analysis: Prpinquity Advisrs 2015 Prpinquity Advisrs LLC

8 Where are pprtunities fr active managers? Eurpe s ETF Future Passive Mutual Fund & ETF AuM (Billins USD) in 2007 (light) and Q (dark) Opprtunities fr Active 8 Lwer Higher $24 $74 $21 $211 $76 $1,027 $1,598 $4,139 0% 10% 20% 30% 40% 50% 60% 70% Passive Mutual Fund & ETF Cncentratin by Glbal Brad Categry Grup The marker size illustrates the Wrldwide passive mutual fund and ETF AuM (as shwn in the data labels, billins USD). The markers further t the right have a higher percentage f assets in passive mutual funds & ETFs (x-axis). Cmmdities, equity and fixed incme have seen the highest increases in passive mutual fund & ETF cncentratin since Investment managers ffering active strategies need t be highly aware f their psitining particularly int thse areas in which activeness (ur term: Degrees f Investment Freedm) are highest. Opprtunities certainly exist in fixed incme and equity but they are away frm narrw building blcks twards differentiated alpha and slutins. Data Surce: Mrningstar Direct. Analysis: Prpinquity Advisrs 2015 Prpinquity Advisrs LLC $33 Allcatin Alternative Fixed Incme Equity Cmmdities $89

9 Active r passive? Eurpe s ETF Future Wrldwide Mutual Fund & ETF Ttal Net Assets 30,000 25,000 Billins USD 20,000 15,000 10,000 ETF MF - Passive MF - Active 5, Q3 9 The Wrldwide mutual fund & ETF universe has grwn frm $17.9 t $28.2 trillin (1.6x) since Actively managed mutual funds made up 89.4% ($16.0 trillin) f all assets in 2007, but tday make up 80.7% ($22.8 trillin). This trend has emerged because inflws fr ETFs and index mutual funds remain strng even when the market, and cnsequently active mutual funds, d prly. Passive mutual fund and ETF assets are mre inslated. This steady increase in passive mutual funds & ETFs illustrates that this trend is cntrlled by frces mre steadfast and reliable than market mvements there is a fundamental change ccurring driven by a cmbinatin f shifting incentive structures and near-term challenges t active vs. passive perfrmance thrugh the extended bull market. Data Surce: Mrningstar Direct. Analysis: Prpinquity Advisrs 2015 Prpinquity Advisrs LLC

10 Years f negative flws fr active equity Eurpe s ETF Future Wrldwide Equity Mutual Fund & ETF Estimated Net Flws Billins USD ETF Mutual Fund Ttal Net Flws YTD The equity mutual fund universe has grwn frm $8.5 t $10.6 trillin (1.2x) while the equity ETF universe has grwn frm $754.4 t $2,097.7 billin (2.8x). Equity ETFs have psitive inflws fr all seven perids abve ttaling $1.3 trillin since Mutual funds have ttaled $669.5 billin in net flws ver the same perid, but experienced utflws in 2008, 2011, and Active mutual funds, fr all glbal categries, have received 58.1% f inflws since 2007 even thugh they claim 80.7% f assets. Relative t their asset base, active funds have been underperfrming in terms f flws fr almst a decade. 10 Data Surce: Mrningstar Direct. Analysis: Prpinquity Advisrs 2015 Prpinquity Advisrs LLC

11 Are active equity managers in truble? Eurpe s ETF Future Wrldwide Equity Mutual Fund & ETF Estimated Net Flws Billins USD ETF MF - Passive MF - Active Ttal Net Flws YTD Actively managed equity funds accunt fr 67.3% f the ttal equity assets in the wrldwide mutual fund & ETF universe ($8.5 ut f $12.7 trillin); hwever, they have accunted fr -3.2% f the flws since 2007 ($63.1 billin in utflws ut f $1,965.3 billin in inflws). In every perid abve, ETFs & index mutual fund flws are psitive while active mutual funds have experienced utflws in 2008, 2011, 2012, and 2015 YTD. In 2012 and 2015 YTD equity as a whle maintained psitive inflws. Investrs have nt been fleeing equity, they are abandning building blck active funds fr cheaper passive ETF & mutual funds. 11 Data Surce: Mrningstar Direct. Analysis: Prpinquity Advisrs 2015 Prpinquity Advisrs LLC

12 Pint f entry Wrldwide net flws since 2007 Eurpe s ETF Future Allcatin Fixed Incme Equity ETF MF - Passive MF - Active 65.9% f Wrldwide equity flws (int mutual funds and ETFs cllectively) since 2007 have gne int ETFs. The largest, mst efficient segments are dminated by a few large players. The SPDR S&P 500 ETF makes up 52.5% f the assets in the US ETF Large Blend Mrningstar categry. Despite Wrldwide trends away frm active funds, allcatin flws since 2007 have been dminated by active mutual funds (96.1%). Fixed incme ccupies the middle grund with active mutual funds accunting fr 70.8% f net flws since Fr equity Wrldwide active mutual fund net flws since 2007 were -3.2% f ttal flws. This negative value is nt pictured n the equity chart. The chart illustrates the divide between the psitive net flws fr passive mutual funds and ETFs. 12 Data Surce: Mrningstar Direct. Analysis: Prpinquity Advisrs 2015 Prpinquity Advisrs LLC

13 Eurpe s ETF Future Peridic Table f Wrldwide Active Mutual Fund Flws (Billins USD) YTD Mney Market Mney Market Fixed Incme Fixed Incme Fixed Incme Fixed Incme Equity Allcatin Allcatin $480 $905 $503 $364 $105 $559 $261 $261 $151 Equity Cmmdities Equity Allcatin Alternative Allcatin Allcatin Fixed Incme Alternative $252 $2.2 $117 $99 $36 $88 $226 $232 $88 Allcatin Prperty Allcatin Alternative Allcatin Alternative Alternative Mney Market Fixed Incme $109 $1.1 $52 $56 $32 $43 $94 $95 $56 Fixed Incme Cnvertibles Alternative Equity Cmmdities Mney Market Fixed Incme Alternative Prperty $95 ($9.2) $41 $42 $8.9 $10 $23 $89 $8.7 Cmmdities Alternative Cnvertibles Cmmdities Prperty Cmmdities Cnvertibles Equity Cnvertibles $3.2 ($36) $18 $19 $0.2 $2.6 $18 $61 $1.8 Cnvertibles Allcatin Cmmdities Cnvertibles Cnvertibles Cnvertibles Prperty Prperty Cmmdities $2.2 ($59) $17 $1.3 ($6.4) $2.2 $6.4 $14 $1.6 Prperty Fixed Incme Prperty Prperty Mney Market Prperty Cmmdities Cnvertibles Mney Market $0.6 ($77) $1.2 ($0.5) ($46) $1.3 ($6.3) $7.7 $1.1 Alternative Equity Mney Market Mney Market Equity Equity Mney Market Cmmdities Equity ($6.8) ($336) ($301) ($483) ($223) ($168) ($16) ($3.7) ($58) Wrldwide active mutual fund assets have grwn frm $15.9 t $22.9 trillin frm 2007 t Q (1.4x). Wrldwide active mutual fund estimated net flws increased frm $608.5 t $803.9 billin frm 2013 t 2014 (1.3x). Year t date flws have reached $295.0 billin, which is nt n pace t match 2013 r The slw, but steady mvement f allcatin and alternative indicates changes in market demand fr active strategies. 13 Data Surce: Mrningstar Direct. Analysis: Prpinquity Advisrs 2015 Prpinquity Advisrs LLC

14 Eurpe s ETF Future Peridic Table f Wrldwide Passive MF & ETF Flws (Billins USD) YTD Equity Equity Equity Equity Equity Equity Equity Equity Equity $159 $222 $105 $160 $138 $228 $340 $411 $270 Fixed Incme Fixed Incme Fixed Incme Fixed Incme Fixed Incme Fixed Incme Fixed Incme Fixed Incme Fixed Incme $32 $36 $101 $74 $67 $118 $57 $167 $113 Alternative Alternative Cmmdities Cmmdities Alternative Cmmdities Alternative Allcatin Alternative $10 $20 $38 $19 $11 $20 $12 $8.5 $18 Cmmdities Cmmdities Alternative Alternative Cmmdities Allcatin Allcatin Alternative Allcatin $8.7 $16 $24 $9.1 $6.9 $3.6 $5.0 $7.7 $6.4 Allcatin Mney Market Allcatin Allcatin Allcatin Alternative Cnvertibles Cnvertibles Cmmdities $4.0 $11 $3.9 $2.8 $2.5 $2.0 $0.9 $1.2 $4.0 Mney Market Allcatin Cnvertibles Cnvertibles Mney Market Cnvertibles Mney Market Mney Market Mney Market $3.2 $0.8 $0.2 $0.3 $0.4 $0.2 ($1.9) $0.5 $2.5 Cnvertibles Cnvertibles Mney Market Mney Market Cnvertibles Mney Market Cmmdities Cmmdities Cnvertibles <$0.1 <$0.1 ($6.0) ($0.9) $0.3 ($0.3) ($42) ($1.1) <$0.1 Wrldwide passive mutual fund & ETF assets have grwn frm $1.9 t $5.4 trillin frm 2007 t Q (2.9x), which mre than dubles the grwth rate f the wrldwide active mutual fund market ver the same perid. Wrldwide passive mutual fund & ETF estimated net flws increased frm $373.0 t $593.8 billin frm 2013 t 2014 (1.6x). Wrldwide flws thrugh the first three quarters f 2015 are $413.0 billin. Passive mutual funds & ETFs, unlike active mutual funds, have already passed 2013 flw ttals. Fr active mutual funds equity, fixed Incme and mney market exhibit an ebb and flw related t glbal market mvements. ETF flws display a higher cnsistency than mutual funds in terms f which categries receive the highest flws. This can be partly attributed t ETFs being used as less expensive building blcks, which is slwly pushing mutual funds ut f equity and int allcatin and alternative. 14 Data Surce: Mrningstar Direct. Analysis: Prpinquity Advisrs 2015 Prpinquity Advisrs LLC

15 Peridic Table f Wrldwide Mutual Fund Flws (Billins USD) Eurpe s ETF Future YTD Mney Market Mney Market Fixed Incme Fixed Incme Fixed Incme Fixed Incme Equity Fixed Incme Allcatin $489 $913 $543 $397 $126 $605 $367 $313 $156 Equity Cmmdities Equity Allcatin Alternative Allcatin Allcatin Allcatin Fixed Incme $282 $2.0 $150 $102 $36 $91 $230 $269 $94.8 Allcatin Prperty Allcatin Equity Allcatin Alternative Alternative Equity Alternative $114 $1.1 $56 $86 $33 $43 $96 $244 $85.9 Fixed Incme Cnvertibles Alternative Alternative Cmmdities Mney Market Fixed Incme Mney Market Equity $107 ($9.4) $42 $56 $9.3 $12 $58 $89 $63.7 Cmmdities Alternative Cnvertibles Cmmdities Prperty Cmmdities Cnvertibles Alternative Prperty $3.2 ($37) $18 $19 $0.1 $3.1 $18 $80 $9.0 Cnvertibles Allcatin Cmmdities Cnvertibles Cnvertibles Cnvertibles Prperty Prperty Cmmdities $2.2 ($57) $17 $1.2 ($5.8) $2.0 $6.5 $14 $3.1 Alternative Fixed Incme Prperty Prperty Mney Market Prperty Cmmdities Cnvertibles Cnvertibles $1.0 ($73) $1.1 ($0.5) ($47) $1.2 ($6.2) $7.8 $1.8 Prperty Equity Mney Market Mney Market Equity Equity Mney Market Cmmdities Mney Market $0.7 ($280) ($305) ($487) ($147) ($96) ($21) ($3.2) ($6.1) Wrldwide mutual fund assets have grwn frm $17.0 t $25.5 trillin frm 2007 t Q (1.5x). Wrldwide mutual fund estimated net flws increased frm $756.2 t $1,079.0 billin frm 2013 t 2014 (1.4x). Flws thrugh the first three quarters f 2015 have reached $467.9 billin, which is nt n pace t match 2013 r Fixed incme is n lnger the mutual fund flw champin it was after the financial crisis. Allcatin has been making headway due t a shifting market incentive structure. 15 Data Surce: Mrningstar Direct. Analysis: Prpinquity Advisrs 2015 Prpinquity Advisrs LLC

16 Peridic Table f Wrldwide ETF Flws (Billins USD) Eurpe s ETF Future YTD Equity Equity Fixed Incme Equity Equity Equity Equity Equity Equity $123 $161 $61 $107 $92 $155 $234 $227 $146 Fixed Incme Fixed Incme Equity Fixed Incme Fixed Incme Fixed Incme Fixed Incme Fixed Incme Fixed Incme $16 $30 $52 $40 $47 $73 $22 $83 $70 Alternative Alternative Cmmdities Cmmdities Alternative Cmmdities Alternative Alternative Alternative $10 $21 $37 $19 $12 $19 $11 $7.8 $19 Cmmdities Cmmdities Alternative Alternative Cmmdities Alternative Cnvertibles Allcatin Cmmdities $8.7 $16 $24 $8.8 $6.5 $1.8 $0.9 $1.3 $2.5 Mney Market Mney Market Cnvertibles Cnvertibles Mney Market Allcatin Allcatin Cnvertibles Mney Market $3.0 $11 $0.2 $0.3 $0.7 $0.2 $0.9 $1.0 $2.3 Allcatin Allcatin Allcatin Allcatin Cnvertibles Cnvertibles Mney Market Mney Market Allcatin <$0.1 <$0.1 <$0.1 $0.1 $0.3 $0.2 ($1.9) $0.4 $0.9 Cnvertibles Cnvertibles Mney Market Mney Market Allcatin Mney Market Cmmdities Cmmdities Cnvertibles <$0.1 <$0.1 ($6.1) ($0.9) <$0.1 ($0.8) ($42) ($1.7) $0.1 Wrldwide exchange traded fund assets have grwn frm $858.1 t $2,751.8 billin frm 2007 t Q (3.2x), which mre than dubles the grwth rate f the wrldwide mutual fund market ver the same perid. Wrldwide exchange traded fund estimated net flws increased frm $225.3 t $318.7 billin frm 2013 t 2014 (1.4x). Wrldwide flws thrugh the first three quarters f 2015 are $240.2 billin. ETFs, unlike mutual funds, are n pace t match the flw levels frm 2013 and This is anther indicatin that the march twards ETFs is nt due t shrt-term market mvements, but a fundamental shift in the industry. 16 Data Surce: Mrningstar Direct. Analysis: Prpinquity Advisrs 2015 Prpinquity Advisrs LLC

17 Abut Eurpe s ETF Future Prpinquity prvides strategic research and advice t investment management cmpanies seeking t measure, ptimize and thughtfully grw their businesses. In supprt f ur clients bjectives, Prpinquity cnducts riginal research int the evlving themes driving the directin f the investment management industry. Prpinquity assists its clients in understanding the drivers f these themes and psitining their capabilities and prducts in the glbal distributin markets. T discuss, cntact: Rland Meerdter Managing Partner rmeerdter@prpinquityadvisrs.cm ph: Fr data inquiries r t receive the charts in Excel, cntact: Will Welde Analyst wwelde@prpinquityadvisrs.cm 17

18 Ntes Eurpe s ETF Future Definitins Wrldwide mutual fund universe a cllectin f funds whse investment type, as defined by Mrningstar, is penended. Wrldwide ETF Universe a cllectin f funds whse investment type, as defined by Mrningstar, is exchangetraded fund. Fixed incme Fr purpses f this reprt and related analytics, we have cmbined the Mrningstar glbal categries fixed incme and tax preferred int a single categry fixed incme. Data All data was pulled between Octber 26, 2015 and Nvember 30, 2015 frm Mrningstar Direct. All data uses September 30, 2015 as an end date. Values in the peridic tables are runded t the nearest billin, but are runded t the nearest hundred millin if the value is less than $10 billin and greater than -$10 billin. Miscellaneus and unclassified funds flws are nt pictured in the peridic tables, but bth categries are included when reprting ttal assets. 18