Passive Investing Dominates Europe, but Active ETFs Gain Traction

The European investment landscape is undergoing a significant shift, with passive investment strategies taking center stage. According to the latest research from Research in Finance's European Fund Selector Study (EuroFSS), Switzerland leads the way in passive product preference, with 56% of passive allocations made in ETFs, while traditional index-tracking mutual funds account for the remaining 44%. This trend highlights the growing confidence in passive ETFs among European investors.

Unlocking the Potential of Passive and Active ETFs in Europe

The Passive Investing Landscape in Europe

Germany and Italy are at a crossroads in Europe's passive investment landscape, with an almost equal allocation split between passive ETFs and index-tracking mutual funds. This balance reflects the increasing traction of passive ETFs, but traditional mutual funds continue to hold their ground. In contrast, Benelux, the Nordics, and the UK trail behind, with only one-third of passive assets allocated to ETFs. Investors in these markets have a stronger preference for the more traditional approach, with over two-thirds of passive assets still tied to index-tracking mutual funds, suggesting they are yet to be fully convinced of the benefits of ETFs.

The Rise of Active ETFs in Europe

As the ETF market matures, investors are faced with a choice: stick with the familiar passive ETFs or explore the new frontier of active ETFs. According to the research, only 21% of European selectors are currently allocating to or recommending active ETFs, with an additional 13% planning to do so by the end of 2024. This reflects the early stages of active ETF adoption in Europe, despite the growing interest in these investment vehicles.

Factors Hindering the Adoption of ETFs in Europe

The research identifies several factors that have slowed the adoption of ETFs in Europe compared to the United States:1. Perception of Lack of Tax Advantages: European investors do not enjoy the same tax perks as their US counterparts, such as tax deferral. However, the research highlights that Ireland-domiciled ETFs can benefit from a reduced 15% withholding tax on US equity dividends, which is a significant advantage for European portfolios heavily invested in US equities.2. Incompatibility with Business Models: The ban on commission payments to distributors providing independent investment advice and portfolio management under MiFID II has created a barrier for the uptake of ETFs, as they are typically sold on the secondary market, where no commissions can be paid.3. Low Familiarity and Understanding: Despite the introduction of ETFs in Europe over two decades ago, there is still a relatively low level of familiarity and understanding of these investment vehicles among both investors and financial advisers, compared to traditional mutual funds.4. Limited Accessibility through European Brokerage Platforms: Many European investors and financial advisers still find themselves unable to access ETF products through their preferred brokerage platforms, reducing the flexibility and appeal of these investment options.

Strategies for Increasing ETF Adoption in Europe

To encourage a greater uptake of ETFs among professional investors in Europe, the research suggests that providers should focus their efforts on education. By helping advisers understand how ETFs can complement their usage of other investment products, such as mutual funds, providers can demonstrate the benefits of ETFs, including low-cost access to specific strategies, tactical allocation opportunities, and increased portfolio transparency.While some of the structural barriers, such as the lack of tax incentives or the continuance of commission payments, may be difficult to change in the near future, a concerted effort on education and highlighting the unique advantages of ETFs can help drive greater adoption in the European investment landscape.