A new report from the Big Four firm, commissioned by the world's largest asset manager, summarises the findings of both quantitative and qualitative interviews with more than 130 UK-based private bankers, wealth managers and financial advisors.

Nearly half of investors in index products intend to increase their so-called “passive” allocations over the next two years, at a time when “all” private bankers are using exchange-traded funds to benefit from heightened liquidity, new research shows. 

Some 39 per cent of investors who use index products – mutual funds constructed to track the components of market indexes – plan to increase their allocation in the next two years, according to a poll carried out by KPMG, commissioned by BlackRock, the world's largest asset manager and index product powerhouse. Simultaneously, all of the private bankers surveyed by the Big Four firm use ETFs, and 86 per cent of wealth managers use them to “benefit from the liquidity and tradability they offer”. 

The UK's rapidly-changing regulatory environment, set to be morphed by incoming European legislation, has also been forecasted by over half (55 per cent) of the nation's wealth managers as a “critical driver” of increased inflows into index funds over the next two years. 

“With the UK wealth industry undergoing significant change as a result of technology, changing regulation and fee pressure, advisors and wealth managers are at a crossroads,” Joe Parkin, head of iShares UK retail and wealth at BlackRock said. He has noted that BlackRock's clients want to know how to achieve the “best net-of-fee performance”, and that ETFs and index products will continue to play a “key role” in building cost-effective portfolios. 

Every month, investments into ETFs and other exchange-traded products, used to offer exposure to non-native markets and products with minimal fees, appear to reach new highs. ETFGI, the independent consultancy and index fund tracker, estimated last month that assets invested in European-listed ETFs and ETPs swelled 28.3 per cent during the first eight months of this year to reach a record-high $734 billion. 

But it is “not a case of either or”, KPMG has said, referring to the battle between active and passive investing. Its survey of more than 130 financial advisors, private bankers and wealth managers, who collectively oversee some £4.5 trillion ($6 trillion) in assets, shows that their clients are “happy” for them to combine active and index products to “deliver sustainable alpha” and to “achieve specific exposures quickly”. 

Transparency changing investment

With the the implementation date of the European Union's second iteration of its Markets in Financial Services Directive, or MiFID II, lurking around the corner, discretionary fund managers and private bankers have noted that the directive will likely lead to “greater scrutiny” of the costs of underlying portfolios, because of its intention to inject more transparency into the industry. As of January 2018, asset managers will be required for the first time to separate the costs of research from trading fees – a process dubbed as “unbundling”. This “may result in more use of index investing products,” KPMG has said. 

Meanwhile, the UK's top regulator, the Financial Conduct Authority, is continuing to pile pressure on money managers after its asset management market study unveiled weak price competition across numerous areas and suggested investors “may pay too much for investment management services”. 

Is index investing an equities-only phenomenon?

Nine-in-10 of those surveyed use equity index products, like ETFs, while nearly two-thirds (60 per cent) use index products for bond exposures. 

“Investors are commonly using index tracking funds in areas of the bond markets where they believe it is more challenging to generate alpha, such as short duration and inflation-linked bonds,” KPMG said. The firm has noted that financial advisors are the “most prolific” users of bond indexing products, while wealth managers often use fixed-income indexing products to access multiple exposures with a range of durations rather than buying a basket of individual bonds. This strategy is sometimes referred to as “bond laddering”.