The exchange-traded fund industry has somehow managed to be part of the solution for investors in this global financial crisis, and not part of the problem.
Now comes the news that British bank Barclays PLC is selling its iShares ETF franchise to a European private equity firm. For investors, the sale raises multiple questions about the ETFs they have been buying lately at rates that can only inspire fear and loathing in the mutual fund industry.
If ETFs are so great, why would Barclays want to get out of the business? What about the group buying iShares - it's entirely unknown to investors, and one of the chief lessons of the financial crisis is to know exactly who you're dealing with on financial matters.
And then there's the question of fees. Private equity firms are all about wringing profits out of the businesses they buy and an easy way to do that would be to raise the low fees that make ETFs such a smart way to invest.
ETFs are index funds that trade like stocks, and iShares is the world's biggest name in the sector. Individual and institutional investors have about $17-billion invested in the company's ETFs in Canada and about $390-billion globally. Do they need to be on red alert now that iShares is set to change hands?
No. It's always smart to be watchful as an investor in these situations, but there's no cause to dump your iShares ETFs.
"From a client perspective, nothing changes," Heather Pelant, head of iShares in Canada, said yesterday.
Barclays has agreed to sell its iShares business for $4.4-billion (U.S.) to raise money that will be used to fortify its financial standing so it doesn't need help from the British government. This isn't a fire sale, but rather a strategic move to sell a valuable asset.
The buyer of the iShares business is CVC Capital Partners, a Luxembourg-based firm with offices in Europe, Asia and the United States. CVC could hardly be more of an unknown quantity to investors, but this isn't an issue.
One reason is that the people running iShares ETFs will remain in place. "The deal includes portfolio managers and traders," Ms. Pelant said. "If I was a client, the question I would have is: Will the same people running my funds continue to run my funds?"
Another reason why investors shouldn't worry about a new owner for iShares has to do with the structure of ETFs. Ms. Pelant explained that, as with mutual funds, ETF assets are held separate from the assets of the company that runs them.
"CVC could completely go under and it wouldn't matter because your assets are held in a segregated, separate entity with trustees on it," she said.
And what about the possibility that the new owners of iShares might try to raise fees in order help pay the cost of buying the company and enhance future profitability? While not inconceivable, such a move seems highly unlikely because of the intense level of competition in the ETF marketplace.
Remember, ETF investors are not like most people who own mutual funds. They pay close attention to fees and are likely to respond to a cost increase by jumping to alternative products.
The most popular ETF in Canada, the iShares CDN LargeCap 60 Index Fund, has a management expense ratio of 0.17 per cent, which compares to about 2 per cent for many of the most widely owned Canadian equity mutual funds. Ms. Pelant said the fee advantage is a key to the success of ETFs.
"It's such a core part of our value proposition. We're not aiming to be the low-cost provider but we're definitely aiming to be cost effective and cost efficient."
It's possible that, freed from being a division of a bank, iShares might even grow at a faster rate than before. That would be bad news for the mutual fund industry.
The iShares people say that, according to preliminary estimates, ETF companies in Canada had a net $1.6-billion flow into their products in the first quarter of the year, while fund companies faced redemptions of $550-million on a net basis. These numbers refer to long-term funds, which means they exclude the money market category.
The funny thing here is that the ETF sector looked ready for a comeuppance a year or so ago as it introduced ever-more contrived and arcane products to build market share. Some of these funds are disappearing, but the basic ETF benefits of low costs, transparency, tax efficiency and flexibility endure.
That's why ETFs are part of the solution today for investors. Barring any crazy moves to raise fees, you can expect iShares to continue to be a part of it.
© 2007 The Globe and Mail. All rights reserved.
