THE INVESTMENT: Mr. Hecher, you have been active in the ETF industry for many years. How has the market changed?
Claus Hecher: I moved into the ETF industry in 2008. Since that time, the market has changed dramatically – especially in terms of volume. This year alone, we have already seen record inflows of 187.6 billion euros into ETFs in Europe at the end of November – significantly more than in 2023 with 127.7 billion euros. The largest chunk of this, namely 75.9 billion, flowed into US stocks. Global equity ETFs were the second big drawcard with 58 billion euros. European ETFs only came in at 6.3 billion euros, emerging markets at 7.2 billion euros. When it comes to bonds, government bonds dominate with 21.7 billion and corporate bonds with 11 billion.
Why this strong US dominance?
Hecher: There are solid economic reasons for this. Over the past ten years, the US economy has grown on average 0.9 percentage points faster than that of the EU. This lead in GDP growth is of course reflected in the price development of stocks. Added to this is the industry structure: the big tech companies such as Apple, Google and Meta are based in the USA. In the Dax we only have one really large software company in SAP. If you believe that tech companies will continue to play a significant role in the future – and I assume they will – that speaks for further outperformance of American stocks.
In contrast to ETFs with a US focus, the situation with ESG is significantly less rosy. How do you explain that?
Hecher: That's right, the share of sustainable ETF inflows is declining. In 2021 and 2022, half of the new money flowed into sustainable ETFs; in 2023 it was only 17 percent. There are several reasons for this: First of all, regulation has become very complex – that is not helpful, even if regulation is fundamentally important. If the rules for funds are not congruent, this creates friction points for bank advice that inhibit sales.
Are there other reasons for sin?
Hecher: An important point is performance development. The first sustainable equity ETFs had a very strong profile with many exclusions. Often 75 percent of the stocks were removed from the standard index because they did not meet the sustainability criteria. In 2021 and 2022, these strategies have surpassed them – the thinking was: at some point you will no longer need oil stocks, everything is moving towards renewable energies. Then came the Ukraine war, and suddenly oil and gas stocks were in demand again. The stronger sustainable indices missed this rally.
How did the industry react to this?
Hecher: There are now much more pragmatic approaches. The new sustainable indices have less strict exclusion criteria. Of course, there is still “basic hygiene” – no controversial weapons manufacturers, no tobacco manufacturers and certain restrictions in the oil and gas sector. The big difference lies in the selectivity: Instead of excluding 75 percent of the stocks, 75 to 80 percent of the stocks now remain in the index. This leads to a significantly lower tracking error compared to the standard index.
What does this mean specifically for investors?
Hecher: An example: When strengthening sustainable indices, the tracking error is often 5 percent – this means large fluctuations compared to the standard index. With the newer, more pragmatic approaches, we achieve values of around 1 percent through optimization.
That is what the market is now asking for: sustainability, yes, but with manageable deviations from the standard index.
Active ETFs are a big trend. They are already very successful in the USA – will this also become established in Europe?
Hecher: The success in the USA initially has tax reasons. With classic investment funds, price gains must already be taxed in the fund. This control does not take place in ETFs. In Europe the motivation is different: Here it is about offering your own investment strategies in ETF format – and at significantly lower costs than with classic active funds. Instead of 2 percent per year, investors often only pay 0.2 to 0.4 percent.
Where do you see the biggest advantages of active ETFs?
Hecher: An important point is ESG implementation. For us, the motivation is to use the active element to improve the ESG profile of the portfolio compared to an index. Take corporate bonds: In a classic index ETF you can hardly manage to have 100 percent sustainable investments. With active management we can weed out problematic bonds and thus create an Article 9 fund under the EU Disclosure Regulation.
What other benefits does the active approach to ESG integration offer?
Hecher: An important point is flexibility in the event of controversy. In a classic index, you usually have to wait until the next rebalancing date to exclude a company – in extreme cases this can take six months. With active ETFs, we can theoretically react from one day to the next. In addition, we are not dependent on a single ESG data provider, but can use different sources and compensate for their respective weaknesses.
Could it get to the point in the future where investors only turn to active ETFs instead of classic stock funds? After all, they also offer active management, but at significantly lower costs.
Hecher: The trend is clearly heading in that direction. In the USA, this development was strongly encouraged by tax advantages – we do not have such a catalyst in Europe. But there are other compelling reasons why active ETFs can be successful here too. ETFs are generally known for three things: favorable conditions, high transparency and great flexibility. Investors' cost awareness is constantly increasing.
We are already seeing some fund managers increasingly offering their strategies through active ETFs. The thought process is pragmatic: If classic investment funds are becoming increasingly difficult to sell, then it is better to stay on the market with an active ETF – even if the margin per product is lower.
But could the business still be profitable due to the higher volume?
Hecher: That's exactly the point.
Many German investors traditionally rely on the Dax. Given the sluggish economy and the problems in the automotive industry, is this still appropriate?
Hecher: Investment behavior has changed significantly. When I came into the ETF business in 2008, private investors mainly bought DAX ETFs. Today, global indices such as the MSCI World are much more in focus. But the DAX is better than its reputation: Most DAX companies are globally positioned and do most of their business outside of Germany. Just because the German economy is weakening doesn't mean that DAX companies have to suffer the same way.
Speaking of diversification – how investors should prepare their ETF portfolio to be crisis-proof?
Hecher: The first step is to define your personal risk profile and derive the weighting between stocks and bonds. You can also add raw materials – whether mixed raw materials or just gold is something everyone has to decide for themselves. The trend in savings plans is interesting: the younger generation in particular is using ETFs to build assets. If you have 20 or 30 years until retirement, the equity portion of your investments can be very high. The closer you get to retirement, the more you should think about a more conservative mix.
What do you expect for 2025?
Hecher: US stocks are likely to continue to be more promising than European stocks – although Europe should not be neglected. The development of interest rates will be exciting: the USA is very fond of debt, regardless of the government, and the Republicans have historically been even more so than the Democrats. That could lead to rising long-term dollar interest rates while central banks cut short-term interest rates again. The yield curve is also becoming steeper and more normal again.
In such a scenario, investors should opt for shorter maturities in bond ETFs.
Are there regions outside the US and Europe that you find interesting?
Hecher: The Japanese stock market has delivered a similarly good performance as the US stock exchanges this year. After a period of consolidation, Japanese stocks are still doing well. The question is whether they can continue with US stocks. In any case, our strategy team declared Japanese stocks to be a solid investment.
Some critics also see the high ETF inflows as a risk. Does passive investing lead to higher market fluctuations?
Hecher: I don't think so at all. When I was a stock market trader when I was younger, we had completely different fluctuations – and that was at a time when there were no ETFs yet. What analysts tend to criticize is that ETFs automatically invest in large companies based on market capitalization without questioning their quality. But that also presents opportunities: If ETFs become too dominant, opportunities for active management arise.
A quick outlook at the end?
Hecher: The ETF market will continue to differentiate. In addition to classic passive products, active ETFs will gain importance. When it comes to sustainable investments, I expect a return to more pragmatic approaches. And the basic rule of diversification is becoming more important than ever – even if the USA will probably remain the driving force.
About the interviewee
Claus Hecher has been Regional Head of ETF Sales DACH and Nordics at BNP Paribas Asset Management since 2023. He previously held senior positions at Natixis Global Asset Management and Blackrock as well as at Deutsche Bank. He holds a degree in business administration and business administration and management from the Ludwig Maximilian University of Munich.
