BMO Global Asset Management is to withdraw from the European ETF market. Its retreat raises questions for investors and for issuers.

BMO Global Asset Management is to close its European ETF business.

In a letter to shareholders in its ETFs, the Montreal-headquartered asset manager announced its intention to close all of its London-listed ETFs and cease managing ETFs domiciled in Europe.

The news comes a little over four years after it entered the market.

BMO said the decision was based on a variety of factors, including the current level of assets under management and projected asset growth in the current market environment.

Effective on or about 21 January 2020, shares in its ETFs will be redeemed at the applicable net asset value per share. Settlement of the shares will take place within ten business days from the effective date.

The funds will remain open for redemption until this date.

Prior to their closure, BMO has advised that the funds’ assets may decrease to a level whereby they can no longer be managed efficiently in line with their underlying indices. For investors remaining in a fund, this means positions may start to be converted into cash resulting in material tracking error. Despite this, however, investors remaining in the funds will continue to incur the management fee.

For investors caught up in the funds, the closures create a headache in part because they will need to find an alternative ETF to deliver the desired exposure (and incur trading costs for the privilege) but also because the closures could trigger taxable events such as capital gains realizations.

This raises some important questions with respect to fund due diligence.

Issuers of ETFs with modest levels of assets under management are quick to assert that an ETF’s low AUM should not be a barrier to investment. Their argument being that AUM or quoted trade volumes do not reflect true underlying liquidity which should be measured at the constituent level. Of course, this is correct, but such assertions fail to take into account a fund’s commercial viability. Often this should be a more important consideration.

Allan Lane, Managing Partner and Investment Manager at Twenty20 Investments, says, “As an institutional investor, the minimal requirements that arise out of a due diligence process would in most instances rule out quite a large number of ETFs with very limited assets or limited track record. However, given the size of a typical retail investment, those same requirements in terms of AUM are not surprisingly less onerous.

“After today’s news from BMO, it might be time to batten down the hatches and revisit the due diligence. Even then, it might not have stopped an institutional investor choosing BMO’s high-yield bond ETF, for example, which has well in excess of £100m in AUM.”

BMO’s withdrawal from the ETF arena also asks questions of other, what might be called “sub-scale”, ETF issuers and those asset managers contemplating an entry.

Fullgoal, GF International and ZyFin are a few of the smaller names that have had a crack at launching ETFs and failed. There are other casualties and more to come.

Others have sold up, like Think ETF to VanEck or Boost to WisdomTree. Even some of the larger issuers, such as Source and ComStage, have sought the sanctuary of a larger parent (Invesco and Lyxor, respectively), although other factors and motivations also played a part in those transactions.

On top of this, countless individual ETFs have closed over the years with distinctly less fanfare than at their launch. Invesco, BlackRock, UBS, and China Post Global, to name but a few, have all stealthily closed funds or delisted share classes in recent months creating potential problems for investors. (That said, some of the funds that have closed failed to accumulate any assets beyond their seed capital).

BMO’s ETF offering in Europe comprises thirteen ETFs, highlights being its $182m BMO Barclays Global High Yield Bond (GBP Hedged) UCITS ETF (ZHYG LN), half the assets of which have been added in the past year, and the $183m BMO Bloomberg Barclays 1-3 Year Global Corporate Bond (GBP Hedged) UCITS ETF (ZC1G LN)). At the issuer level, it has assets under management of around $670m.

Many would have thought this not-immaterial level of AUM would have been enough to sustain the business. But with estimated annual fee revenue of just $1.7m and a price war continuing to put pressure on fees, it proved insufficient to reassure the powers that be in Montreal and Toronto, London, and Edinburgh where it has offices.

Its closure is a timely reminder of the requisite scale and product focus needed to sustain a standalone ETF platform.

Hector McNeil, an industry veteran and Co-CEO of white-label ETF issuer HANetf, says potential new entrants, as well as some of the smaller existing issuers, should consider a turnkey solution rather than building out a dedicated platform.

“On BMO I do believe more generally, rather than specifically to BMO, that for many of the sub-scale issuers in Europe it would make more sense for them to work with HANetf. The issue they have is that to get to scale the investment is significant. So they are effectively half pregnant. Close or invest. The investment required is probably millions – and even then no guarantees. The HANetf model is way more scalable and optional,” says McNeil.

“Personally, I think if HANetf had been around when they [BMO] first looked at ETFs, it would have made massive sense for them to partner with us as we offer collective scale, or scale through aggregation, as I like to call it. We are talking to many of these sub-scale platforms and hope to land one. I am sure others will follow.”

There are perhaps question marks, too, over BMO’s product launch choices. For example, despite being a Canadian financial giant with demonstrable pedigree, it did not offer a Canada-linked ETF. UBS, meanwhile, has, over the lifetime of BMO’s European ETF adventure, quietly added an additional $1.5bn (approx.) in assets to its 33bps Luxembourg-domiciled Canada ETF (granted, some of these inflows might have been internally directed UBS-managed money). And its equity income products failed to stand out in a crowded market.

Of course, it is not all gloomy for smaller ETF issuers or those of all stripes and sizes eying an entry. There remain plenty of product development opportunities.

European domiciled ETFs offering exposure to credit volatility (Tabula is a fine example of a successful ETF start-up, see Tabula’s credit volatility premia ETF surpasses €150m milestone), Saudi Arabian and Kuwaiti equities, low carbon real estate, and ESG credit are all examples of recently launched ETFs offering exposure to previously uncharted markets that have quickly gathered assets.

Then there are the likes of JP Morgan, Franklin Templeton, LGIM, Fidelity, and Goldman Sachs which have all entered the European ETF space in recent years and appear to be doing just fine. It helps of course to have their financial strength and distribution capabilities.

But perhaps the real opportunity for smaller and fledgling issuers is in active ETFs. This is an area ripe for exploitation by boutique, niche players with proprietary strategies. Active ETFs can justify higher fees and fee income doesn’t have to be shared with an index provider, further enhancing the commercial proposition. Such strategies are gaining traction in the US thanks to a dynamic ETF industry and an increasingly sympathetic regulator.

To avoid BMO’s fate, European fund management executives and ETF entrepreneurs should perhaps take note.

BMO’s European product range as at 26 November 2019 (AUM approximate, fee revenue estimated):