ETF Stream's Product Panel has covered most of the major investment themes from 2019 as fund providers have continued to innovate in their ETF offerings.

From ESG to fixed income, emerging markets to crypto-currencies, the eclectic nature of today’s European ETF scene was reflected by the choices of the panel.

It is the first of these, the drive towards ever more environment, social and governance-led investment, that was featured early in the year when the panel took a look at the BNP Paribas Fossil Free ETF.

“We can overall observe an increasing demand from our clients regarding ESG strategies, both within the equity as well as the fixed-income space,” Timo Pfeiffer, chief markets officer at Solactive, noted.

He said the ETF showed a “positive approach” and was another step towards ESG becoming a mainstream investment trend, adding it was “no surprise” it came from BNP Paribas which has been focused on sustainable investment for many years.

While ESG-based funding of corporations encourages companies to seek a positive ESG profile and a low-carbon impact, the lack of a bond-specific analysis eventually “may lead to the financing of projects that are less green than others”.

Henry Cobbe, head of research at Elston Consulting, made a similar point, saying the trend to exclude fossil fuels has been focused on the equity side.

“It has been more complex to achieve within a bond allocation,” Cobbe continued. “BNP Paribas’ recent launch could help change that.”

Oiling the wheels

As far from fossil free as you can get, in March and April events in emerging markets were the focus of the panel and specifically the opening up of the investment opportunities in the oil-rich middle east via the various EM index inclusion moves made by the major index providers.

First up, ahead of the Saudi Aramco IPO at the end of the year, Invesco’s Saudi Arabia ETF came under the microscope. “The index is not particularly well-diversified, as might be expected, and could become more concentrated if the long-awaited IPO of Saudi Aramco finally happens,” Peter Sleep, senior investment manager at 7IM, predicted.

Noting the heavy weighting to financials and materials – which combined makes up 80% of the index at the time of the listing – he suggested it may make the index “quite volatile”.

“In order to stay in line with UCITS guidelines the largest company is capped at 35% of the index and there is a 20% cap for any other index constituent,” he added. “Such constraints are not unusual in the index world.”

James McManus, director of ETF research at Nutmeg, suggested single-country emerging markets can often be much more expensive to trade than the wider EM broad index products with typically much smaller secondary markets for the ETF. He added investors need to understand local market dynamics and full assess costs and ensure this is factored into their investment view and strategy.

Referring to the MSCI EM inclusion that prompted the fund, he said it was a “watershed moment for the Saudi stock market”, given it will become one of the 10 largest country holdings in the MSCI Emerging Markets index by market capitalisation.”

Still, Nicolas Rabener, managing director of FactorResearch, suggested investors in any Saudi-focused fund should beware of the risks. “In the case of Saudi Arabia, a collapse of the oil price, a failure to transform their economy, further wars in the Middle East, or a change in regime are all risks that can quickly turn investor sentiment negative,” he added. “Selecting a diversified emerging market ETF is likely a better approach to benefit from the cheaper valuations and higher growth of emerging markets.”

The Saudi fund was followed by the HANetf Kuwait ETF in April and again the panel pointed to the caveats that needed to be understood. “Not only should investors in this ETF fully understand the drivers of the Kuwaiti economy and the reforms currently being undertaken but also be comfortable with investing in an emerging market, which is likely to involve heightened regulatory, political and liquidity risks,” Kenneth Lamont, ETF analyst Morningstar, said.

As with the Saudi fund, concentration is an issue. “While the index has relatively little exposure to oil and gas, it is dominated by financial stocks, which can be very volatile, and the index has only 13 companies in a market which will have relatively limited liquidity,” Ben Seager-Scott, head of multi-asset at Tilney, said, adding that he saw the fund as a “useful tool in the toolbox for some investors”.

Turning to May and it was ESG funds that were back in the spotlight following the launch of the UBS S&P 500 ESG ETF in May.

7IM’s Sleep was somewhat concerned about the lack of consistency with the former fund, suggesting its exclusions were potentially confusing compared with the same provider’s SRI fund. “Without consistency, the good intentions of responsible investing are nullified,” he suggested. “Responsible investing is relatively young and I hope UBS and the index providers up their game and that these differences are ironed out in due course to have the maximum impact.”

Cobbe hit a similar theme. “There are very different degrees of exclusion/inclusion criteria for each ESG index, so a clear understanding of the screening process used and how the final composition compares to other ESG options is essential. Always look under the bonnet.”

The second half of the Product Panel review of the year will appear tomorrow.