Morningstar Direct Europe ETF Asset Flows Update - Q ETFs Pull In EUR 47.9 Billion of Net New Money in 2016

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1 ? Morningstar Direct Europe ETF Asset Flows Update - Q ETFs Pull In EUR 47.9 Billion of Net New Money in 2016 Morningstar Inc January 2017 Jose Garcia-Zarate Associate Director Passive Strategies Research jose.garciazarate@morningstar.com Executive Summary The European exchange-traded-fund market attracted EUR 11.5 billion in net new money in the fourth quarter of 2016, bringing the grand total for the year to EUR 47.9 billion. Assets under management increased to EUR 546 billion from EUR 466 billion in Equity ETFs saw a turnaround in fortunes in the fourth quarter and closed 2016 with net inflows of EUR 13.6 billion and assets under management up to EUR 365 billion from EUR 319 billion in US exposure was strongly favoured, whereas emerging markets took a knock after the US election. Fixed-income ETFs saw net outflows of EUR 2.5 billion in the fourth quarter as risk-on sentiment, and higher US interest rates took their toll. Despite this, fixed income was a success story for the European ETF industry in 2016, pulling in EUR 20.6 billion in net new money and increasing its market share to 24.1% from 22.6% in Important Disclosure The conduct of Morningstar s analysts is governed by Code of Ethics/Code of Conduct Policy, Personal Security Trading Policy (or an equivalent of), and Investment Research Policy. For information regarding conflicts of interest, please visit: Strategic-beta ETFs netted EUR 9 billion of net new money in This represented 19% of the total money flowing into European ETFs and was strongly up from 10% in Assets under management grew to EUR 43 billion in 2016 from EUR 31 billion in IShares was the largest money-gatherer in 2016 and retained a 46% market share. The year 2016 was bad for db x-trackers, whereas State Street, Vanguard, UBS, and Amundi all gained market share. Exhibit 1 Europe ETF Market Annual Net Flows and Asset Growth (EUR Billion)

2 Page 2 of 6 Flows by Main Asset Class Exhibit 2 Europe ETF Net Flows and AUM by Broad Asset Class (EUR Billion) Equity Equity ETFs netted just shy of EUR 15 billion of net new money in the fourth quarter of 2016, greatly surpassing the EUR 4.3 billion of inflows in the previous quarter. The strong Q4 outcome allowed equity ETFs to close 2016 in positive money-flow terrain, with EUR 13.6 billion directed to the asset class. This was significantly down from the EUR 43.2 billion gathered in 2015, but the trend into 2017 seems to be pointing in the right direction. Assets under management in equity ETFs amounted to EUR 356 billion at the end of 2016, up from EUR 319 billion a year earlier. This implies capital appreciation of EUR 23.9 billion on top of the net inflows. The rotation to equities mostly developed markets gathered speed after Donald Trump s victory in the US election. US equity holdings were particularly favoured, with investors taking a broad positive view about the US President-elect s economic views. The so-called Trump rally was driven by expectations for a large-scale spending programme to renew US transport infrastructure, as well as on the potential boost for US manufacturing via the implementation of trade protectionist policies. Broad European and eurozone large-equity ETFs were also at the top of investors' preferences in the fourth quarter. This was a remarkable turnaround in fortunes after a rather negative third quarter, when valuations were dragged down by the troubles in the German and Italian banking sectors. Sentiment was particularly positive in November and December, with investors shrugging off the Italian constitutional referendum as a nonevent. Still, these market exposures registered net outflows for Emerging-markets equity ETFs were on the back foot in the fourth quarter on a combination of a strengthening USD and concerns that Trump s protectionist views mean trouble for these countries. The outflows registered in the fourth quarter only dented what was a good 2016 for the asset class close to EUR 5.3 billion of net new money was placed in global emerging equity ETFs but leave a question mark on sentiment for 2017.

3 Page 3 of 6 Exhibit 3 Equity ETF Annual Net Flows by Morningstar Category (EUR Billion) Fixed Income Investors pulled out EUR 2.5 billion of fixed-income ETFs in the fourth quarter. Despite this quarterly setback, fixed income closed 2016 as the top-money-gathering asset class, with over EUR 20.6 billion of net new money flowing into bond ETFs. Assets under management grew to EUR 131 billion from EUR 105 billion in Fixed-income ETFs now represent 24.1% of the European ETF marketplace, up from 22.6% a year earlier. Sentiment around fixed income in the latter stages of 2016 was strongly conditioned by the firm expectations and subsequent delivery of an increase in interest rates by the US Federal Reserve. Unsurprisingly, US government-bond ETFs and, above all, emerging-markets debt, were on the back foot. The prospects for these markets into 2017 has turned sour, as the Fed has hinted at more rate hikes. As was the case in previous quarters, eurozone government debt remained firmly at the bottom of investors preferences. By contrast, EUR-denominated corporate-bond ETFs both investment-grade and high-yield were the top money-gatherers of 2016, cashing in around EUR 8 billion of net inflows in aggregate over the year. European Central Bank support particularly the inclusion of nonbank corporate debt in the quantitative-easing programme was a key driving factor. Whether it proves so effective in 2017 looks questionable. The ECB remains committed to an ultraloose policy stance, but investors now rightfully worry about the pull factor of higher US interest rates in global fixed-income markets. Irrespective of the fortunes for the asset class, ETFs have made great strides in being accepted as investment vehicles for fixed income. There remain concerns and an ongoing need for education, most notably around the issue of ETF trading and liquidity. However, all ETF providers concur in identifying fixed income as one of their key growth areas in the coming years. Exhibit 4 Fixed-Income ETF Annual Net Flows by Morningstar Category (EUR Billion)

4 Page 4 of 6 Commodities Exchange-traded commodities and commodity ETFs experienced EUR 0.9 billion in net outflows in the fourth quarter. The improving sentiment around equities during the period lessened the need to seek the safety of the likes of gold, which is dominant in terms of product offering for this segment of the exchange-traded product marketplace. The positive run in the previous three quarters ensured that commodities closed 2016 in positive flows terrain, with over EUR 12 billion of net new money into the asset class. Assets under management rose strongly to EUR 43 billion from EUR 28 billion at the end of 2015, largely on the rebound of gold prices out to October 2016, as well as on the bottoming out of other commodity prices. Strategic Beta Exhibit 5 European Strategic-Beta ETF Flows and AUM (EUR Billion) Strategic-beta commonly known as smart beta ETFs attracted over EUR 1.3 billion of net inflows in the fourth quarter, down from EUR 2.4 billion in the previous period. This represented 11.5% of the net inflows for the entire ETF market, down from 13.6% in the third quarter and from an average of 25%-30% in the first two quarters of The decline came because of investors pulling out of positions in riskoriented strategic-beta ETFs for example, minimum volatility. As was the case with fixed income or commodities, the risk-on scenario of the fourth quarter undermined the case for investing in these riskcontrolling strategies. In 2016, strategic-beta ETFs netted EUR 9 billion in net new money, up from EUR 7 billion in More important, despite the decline in the take-up experienced in the second half of the year, net inflows into strategic beta represented 19% of the total money flowing into ETFs during This was strongly up from 10% in 2015 and signalled that ETF investors are increasingly looking beyond tried-and-tested plainvanilla market exposures. Assets under management in strategic-beta ETFs totalled just over EUR 43 billion at the end of 2016, up from EUR 31 billion a year earlier. In the context of the European ETF market, strategic-beta products now take up a market share of 8%, up from 6.6% in The bulk of assets continues to be placed in return-oriented strategies.

5 Page 5 of 6 Flows by Provider Exhibit 6 Top 10 Europe ETF Providers (Ranked by AUM of 2016) (EUR Billion) IShares topped the ETF providers list in all quarters of In the fourth quarter, it netted EUR 5.8 billion of new money, bringing the grand total for 2016 to EUR 26.4 billion. IShares market share has remained stable around 46% for the past three years and there seems to be little prospect of this situation changing substantially anytime soon. By contrast, the fight amongst the other providers has become quite interesting. Db x-trackers hung on to second position in However, there is no disguising that this was a rather bad year for it. Investors pulled out EUR 5.3 billion, and its market share as measured in terms of assets under management dropped to 9.8% from 11.9% in (Note this excludes the range of db-x ETCs, although including these would not alter the message.) Lyxor remains the third-largest ETF provider in Europe and closed the gap in the fight for second position. Interestingly, however, despite moderate annual inflows and an increase in assets, Lyxor s market share also dipped slightly relative to State Street, Amundi, Vanguard, and UBS did much better in attracting investors attention and have gained market share at the expense of both Lyxor and, above all, db x-trackers. There is no single common reason explaining these providers good results in Each seems to have succeeded on a combination of specific drivers such as State Street s timely buildup of a physically replicated fixed-income ETF range, the enduring appeal of Vanguard s flagship S&P 500 ETF, or UBS leading moves in the field of currency-hedged ETFs and ETFs with environmental, social, and governance themes. K

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