Thought Winter 2008

Comprehensive servicing operation has a major impact on ETF Providers

E-mail

J.P. Morgan is one of the ETF industry's premier providers, offering a full suite of services for the development, launch and servicing of ETFs.

Susan Ebenston
Global Funds Services
Business Executive,
J.P. Morgan Investor Services

Following is a reprint of a conversation with Susan Ebenston, Global Funds Services Business Executive, J.P. Morgan Investor Services, and The London Times.

For investors, ETFs are simple: You buy and sell them just like stocks, and they provide easy, low-cost access to entire asset classes—stocks, bonds, commodities and more.

Behind the scenes, however, a lot of work goes into making ETFs function smoothly. J.P. Morgan is a leading service provider to the ETF industry, helping develop new and innovative fund structures, and providing global custody, fund accounting and administration, transfer agency and basket settlement services.

Who is investing in ETFs?

Susan Ebenston: It runs the gamut. Institutions were the first to embrace ETFs in the early 1990s. Traders and fund managers realised that ETFs were the perfect tool to execute tactical asset allocation strategies, equitise cash and create low-cost core positions in a portfolio.

Today, hedge funds are the largest traders of ETFs. They use ETFs to gain quick access to the market, particularly on the short side. More recently, the retail market has really taken off. Retail investors now hold more than half of all ETF assets in the US.

Why have ETFs grown rapidly in popularity?

Susan Ebenston: They’re low-cost, highly liquid, and provide an easy way to gain targeted exposure to the market.

In a lot of ways, ETFs combine the best of both stocks and mutual funds. Like mutual funds, they offer quick diversification, often with lower costs.

Like stocks, you can buy and sell ETFs throughout the trading day, whereas mutual funds can only be traded once per day, after the market closes.

ETFs are also fully transparent: they publish their holdings on a daily basis, so you know exactly what you’re buying.

Finally, there’s been a huge amount of innovation in the ETF market. There are a number of areas where ETFs offer the only liquid way to access a particular asset class.

Are there still significant differences between the US and UK markets?

Susan Ebenston: Yes, but they’re narrowing. In general, the US market is bigger and more mature: There are more funds, with more assets, and generally more trading volume. In the US, ETFs hold about 4% of all assets invested in mutual funds; in Europe, that figure is closer to 1%.

But the European market is growing faster than the US market, and European ETF providers have been quite innovative. For instance, the first commodity and credit index ETFs were launched in Europe, not in the US. In general, the European market is more institutional - like the US market in its early days. It’s also more fragmented, with multiple exchanges and multiple country listings.

What are some of the challenges to servicing ETFs?

Susan Ebenston: ETFs require everything from a servicing standpoint that a conventional mutual fund requires, and then some. You have the core responsibilities of trade settlement, custodian work and record keeping. But because ETFs trade throughout the day, you also have to constantly calculate and publish the indicative value of the portfolio, accrue dividends, interest and stock lending revenue, and more.

How well the service provider handles these tasks can determine the tax efficiency and internal costs of the portfolio. It has a real impact on returns.

Remember: ETFs are a low-cost vehicle, so services must be highly automated and low cost.

What are the most important recent innovations?

Susan Ebenston: Over the past few years, we’ve seen an explosion of new ETFs. The first leveraged and short ETFs launched in February 2005, and they now have over $20 billion in assets. We’ve seen ETFs open up important new asset categories like private equity (October 2006), infrastructure (January 2007) and frontier markets (May 2008).

That’s just the tip of the iceberg. Everything from hedge fund strategies to international fixed income funds are in the works. Active management is coming, too. The growth trajectory is huge.

For more information, please visit our Website at www.jpmorgan.com/wss