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Source to cut ETFs ahead of Invesco acquisition

London-based exchange traded fund (ETF) provider Source announced that it would close two ETFs similar to ones run by Invesco (IVZ:NYQ), just two days before signing a takeover deal with this asset manager. Invesco is taking over Source, which runs ETFs with assets worth about $18bn (£13.94bn) in-house and offers ETFs run by external managers with assets worth roughly $7bn. The takeover will complete in the third quarter of 2017, the latest in a series of acquisitions in the European passive funds market by a US asset manager.

Source has informed shareholders that it is delisting Source FTSE RAFI UK Equity Income Physical UCITS ETF (DVUK) and Source FTSE RAFI US Equity Income Physical ETF (DVUS) from the London Stock Exchange (LSE) on 12 June. But Source says the decision to close the ETFs is not connected to the Invesco deal. It says they are being closed because they are "no longer economically viable".

Source FTSE RAFI US Equity Income has assets of just $7.4m, compared with PowerShares FTSE RAFI US 1000 UCITS ETF's (PRUS) $2.8bn-plus. Source FTSE RAFI UK Equity Income has assets of £7.4m, but this is more than PowerShares FTSE RAFI UK 100 UCITS ETF's (PSRU) assets of £7.2m. The ETFs track similar indices to each other.

In advance of Invesco's acquisition of Source, commentators said it could make sense to cut ETFs tracking the FTSE RAFI indices, a family of value-style benchmarks, as this is one of the few areas of overlap in the two ranges, and many of the ETFs tracking these have failed to attract substantial assets.

Invesco's current 29 London listed ETFs are weighted by factors such as low volatility or high income, for example PowerShares EQQQ Nasdaq-100 UCITS ETF (EQQQ) and PowerShares FTSE UK High Dividend Low Volatility UCITS ETF (UKHD). When it acquires Source its range will include 'plain vanilla' broad equity ETFs such as Source S&P 500 UCITS ETF (SPXS) and recently launched Source Bloomberg Commodity UCITS ETF (CMOD), the lowest priced broad commodity ETF listed in London, with an ongoing charge of 0.19 per cent.

Invesco's takeover of Source is said to be motivated by a desire to build up a range of broad, market-cap-weighted ETFs in Europe, where so far it has failed to make inroads. Despite being among the top five ETF providers in the US in terms of assets under management (AUM), Invesco has just a 0.4 per cent share of the European ETF market, where it has failed to reach the same position as US giants such as BlackRock (BLK:NYQ) and Vanguard.

The deal is a sign of the intensely competitive nature of the passive market. European-listed ETFs' AUM reached a new record of $640bn at the end of March 2017, according to ETF consultancy ETFGI, but asset managers need a huge volume of assets to generate profits because they are under pressure to offer ETFs at ever lower costs. Detlef Glow, head of EMEA research for Thomson Reuters Lipper, says: "The ETF industry is an industry where size matters, so a takeover is one of the ways to gather critical size in the market."

As a result, iShares, Deutsche Asset Management and Lyxor control close to two-thirds of the total AUM of the European ETF market, according to Morningstar, and smaller players struggle to survive. Source, the seventh-largest ETF provider in Europe, had been seeking a buyer since 2016 after being bought by private equity group Warburg Pincus three years earlier.

Alan Miller, founder of wealth manager SCM Direct, says private investors should not expect drastic price cuts to stem from the deal, but said more cuts could be expected if there were other duplicates in Invesco's range.

"There have been so many price cuts to plain vanilla ETFs in recent years that there just isn't much room to reduce costs further," he says. "There is a bit more scope in the fixed-income and smart-beta areas, but broad market ETFs have been bid down to very [low charges]. I don't think this deal will make that much difference to the private investor, but I would have thought that some ETFs could be cut because there is bound to be some overlap."

PowerShares' range did not change much after it was taken over by Invesco in 2006, according to Mr Miller. However, when iShares took over Credit Suisse's ETF business in 2013 it merged several of the funds into its existing ones.

Jose Garcia-Zarate, associate director of passive strategies research at Morningstar, says: "A deal of this type is always a good opportunity to take stock, look at what has worked and what has not on both sides, and proceed accordingly. I wouldn't be surprised to see some funds merge or close."

But the bigger question is what will happen to the Source ETFs that are managed externally.

"Source has always outsourced the management of some of its funds to other entities, and has sought strategic partnerships with reputable asset managers such as PIMCO or Goldman Sachs that also develop the strategies these ETF follow," says Mr Garcia-Zarate. "So will Source's strategic partners want to continue collaborating with Invesco? If the answer is no, then we might see some more closures in Source's range."

Mr Glow says that although Source and Invesco are a good fit, Invesco still has a way to go before being able to boast a full range. He adds that the combined product range will still have many important gaps, "especially in the bond segment. Invesco PowerShares will need to broaden its product range to become a full-range promoter, and profit from professional investors using bond ETFs, a trend that emerged during 2016, when bond funds were for the first time the best-selling product type in the European ETF market."

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By Kate Beioley ,
18 May 2017

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