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Global ETF inflows surge 40% amid ‘tectonic shift’

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Net flows into exchange traded funds have jumped 40 per cent so far this year with the growing shift into low-cost index tracking vehicles forcing the pace of consolidation across the asset management industry to accelerate markedly.

Morgan Stanley agreed last week to stump up $7bn to acquire Eaton Vance while Franklin Templeton paid $6.5bn to buy Legg Mason earlier this year, two deals that illustrate how traditional active managers are being compelled to reconfigure their businesses in response to ferocious competition from ETF providers.

“The pressures on active fund managers to find ways to respond to the rise of ETFs have become irresistible. The growth of ETFs is a global tectonic shift that has gathered pace since the 2007/08 financial crisis.” said Deborah Fuhr, founder of ETFGI, a London-based consultancy.

Investors have ploughed $488.2bn into ETFs (funds and products) in the first nine months of the year compared with $349bn in the same period in 2019, according to ETFGI.

Vanguard holds a clear lead over rival ETF providers as the race to attract investors’ cash enters the final quarter of 2020.

Pennsylvania-based Vanguard registered net ETF inflows of $134.3bn in the first nine months of 2020, up 73 per cent on the same period last year and already surpassing the $119.3bn it gathered over the whole of 2019.

Some asset managers have complained privately that Vanguard’s ETF flows have been inflated because it has allowed clients to switch from the Admiral share class of its mutual funds into the lower cost ETF without incurring any extra charges.

“Not all of Vanguard’s ETF inflows are real,” complained a rival provider that declined to be named.

Vanguard had previously refused to disclose the value of assets that clients have converted into ETFs from existing mutual fund holdings. A Vanguard spokesperson told the FT that $22.8bn of its ETF inflows so far this year were conversions from existing mutual funds.

BlackRock, the world’s largest asset manager, has attracted inflows of $106.3bn so far this year into its iShares ETF unit, only marginally ahead of the $105.2bn registered in the first nine months of 2019.

State Street Global Advisors, the third largest ETF provider globally, has drawn inflows of $21bn so far this year, more than double the $8.1bn gathered in the first three quarters last year. State Street runs the world’s largest gold ETF and has been boosted by record demand from investors for physically-backed bullion ETFs.

Invesco, the number four player globally, has seen ETF inflows increase 22.8 per cent to $19.4bn this year, helped by the strong performance of technology stocks. Invesco’s most popular ETF, known as QQQ, tracks the tech-heavy Nasdaq index, which hit an all-time high in early September.

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Although Invesco’s ETF unit is ahead compared with last year, other parts of its business have suffered substantial outflows that have weighed on the share price of the Atlanta-based asset manager since the start of 2018. Invesco’s share price has rallied over the past week on hopes that Nelson Peltz, the high profile activist investor, will engineer a deal with Janus Henderson. 

The grinding competitive pressures exerted by BlackRock and Vanguard appear to be weighing on other rivals as well. Charles Schwab, one of the most prominent competitors in the ongoing fee war among ETF providers, has seen a disappointing slowdown in 2020. Cash inflows for Schwab’s ETF business have dropped 56 per cent to just under $8bn so far this year.

The S&P 500 reached an all-time high in September but European stock markets have not fully recovered losses sustained earlier this year as a result of the coronavirus pandemic. The relatively muted recovery for European stocks has weighed on new business growth for some ETF providers located in Europe. Amundi and UBS have both seen ETF inflows decline significantly this year.

Rumours have resurfaced that Lyxor, the Paris-based asset manager, will be sold by its owner Société Générale because the French bank wants to strengthen its balance sheet. Lyxor has seen ETF inflows of $1.3bn in the first nine months, a marked improvement compared with 2019 when it registered full-year outflows of $5.5bn, according to ETFGI.



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Staying private: the booming market for shares in the hottest start-ups

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In 2014, an Austrian entrepreneur offered investors a rare chance to purchase shares in Jumio, his fast-growing and profitable payments company. The deal was not a typical venture capital transaction. Instead of purchasing new shares, investors could buy out earlier shareholders, in what are known as private secondary transactions.

Daniel Mattes, who calls himself a “visionary” on his Instagram page and has been a judge on the Austrian version of Shark Tank, the American reality TV series for entrepreneurs, told at least one prospective buyer he had no plans to reduce his own stake in the business, according to a US Securities and Exchange Commission complaint filed in 2019. Mattes also signed off on documents that, according to the complaint, claimed Jumio made a small profit and revenues of more than $100m in 2013 — a significant sum for a three-year-old company.

Two years later, Jumio filed for bankruptcy, and the company’s shares became worthless. In reality, according to the SEC, Jumio had only made one-tenth of the revenues it claimed, and Mattes had bypassed his board of directors to sell about $14m of his own shares.

Jumio’s case highlighted the risks of an opaque but fast-growing corner of finance: the global market for shares in private start-ups such as TikTok owner ByteDance, Elon Musk’s SpaceX and payments company Stripe. In 2019, the market was estimated to host almost $40bn in lightly regulated trades, according to one participant, more than doubling its volume from 2014.

Attendees wear costumes at a TikTok Creator's Lab hosted by ByteDance in Tokyo. The global market for shares in such private start-ups is an opaque but fast-growing corner of finance
Attendees wear costumes at a TikTok Creator’s Lab hosted by ByteDance in Tokyo. The global market for shares in such private start-ups is an opaque but fast-growing corner of finance © Shiho Fukada/Bloomberg

Recently, the market has been hotter than ever. Though private companies have largely tried to restrict trading, brokers say hedge funds, mutual funds and other institutional investors have begun pouring in, buying large blocks of existing shares in start-ups that are nearing initial public offerings or big acquisitions. Often, the investors receive scant rights to information on financial performance.

Technology upstarts and financial institutions including big banks have rushed to capitalise on the interest by brokering deals and forming trading venues, setting up a battle that could fundamentally alter the market’s structure and potentially allow companies to stay private indefinitely.

The boom reflects how cash-flush investors are clamouring for stakes in fast-growing businesses, with low interest rates pushing non-traditional funds deeper into private markets. To meet the demand, brokers now face two key challenges: increasing the supply of shares in desirable companies while preventing fraud and manipulation in a competitive market.

Until recently, private secondary markets resembled “that guy with a trenchcoat that’s selling you watches in Times Square”, says Inderpal Singh, who leads a private secondary market project at the start-up marketplace AngelList. “In the last year, there’s been a big shift.”

chart showing the growing trading volume in private markets

In addition to AngelList, JPMorgan and the software start-up Carta have begun facilitating trades in private companies. They compete with established players like Nasdaq and Forge Global, which purchased the rival marketplace SharesPost in a $160m deal last year, as well as scores of smaller independent brokers.

Carta and some other intermediaries have advocated that the SEC relax restrictions on who can purchase shares in private companies, potentially opening up the market to a broader swath of investors.

But some observers remain sceptical that the growing market can protect investors against bad actors. Mattes, who paid $17m to settle the charges, did not admit or deny the SEC’s allegations, though he resigned from Jumio in 2015 following an internal investigation. The entrepreneur did not respond to questions sent to his personal website.

The rush to expand trading could lead to fraud and manipulation, says Stephen Diamond, a professor of law at Santa Clara University who has studied private secondary transactions.

“All too often in Silicon Valley, people want to basically ignore the consequences of unhealthy market structures,” Diamond says.

Facebook's initial public offer is displayed on a news ticker in New York in 2012. The IPO created a frenzied market where independent brokers facilitated thousands of trades with little oversight from the company
Facebook’s initial public offer is displayed on a news ticker in New York in 2012. The IPO created a frenzied market where independent brokers facilitated thousands of trades with little oversight from the company © Michael Nagle/Bloomberg

The Facebook episode

The debates reflect a decade-long shift in capital markets as companies grow larger than ever in private — securing billion-dollar valuations and “unicorn” status while pushing back their public debuts. As a consequence, start-ups, investors and employees have accumulated trillions of dollars’ worth of shares that cannot easily be bought and sold, barring a public listing or acquisition.

Private secondary markets grew in importance in the lead-up to Facebook’s initial public offering in 2012. Investors rushed to buy the social media company’s shares, creating a frenzied market where independent brokers facilitated thousands of trades with little oversight from the company.

The trades created headaches. One Facebook executive left the company after he reportedly purchased stock ahead of a big funding announcement. Facebook sometimes lost track of who owned its shares, complicating preparations for its IPO.

Facebook’s struggles caused many start-ups to adopt strict clauses in their legal documents that prevented employees from trading shares without company approval. Some companies have gone even further, requiring sellers to receive approval from boards of directors months in advance of any transaction.

Though the restrictions have made trading difficult, brokers say the market has been busier than ever in the past 12 months, with big investors such as Tiger Global Management hunting for shares in start-ups that look like sure bets for blockbuster public listings.

Tiger Global has used secondary sales to gain stakes in companies such as China’s ByteDance and the software group Snowflake, according to fund documents and people familiar with the trades. Other hedge funds and mutual funds routinely purchase new stakes in companies worth tens of millions of dollars, brokers say.

Conference-goers at a Stripe booth during a GeekWire summit in Washington. The boom in private secondary markets reflects how cash-flush investors are clamouring for stakes in fast-growing businesses
Conference-goers at a Stripe booth during a GeekWire summit in Washington. The boom in private secondary markets reflects how cash-flush investors are clamouring for stakes in fast-growing businesses © David Ryder/Bloomberg

On the other side of the trades, existing shareholders such as venture capitalists have sought to unload stakes in highly-valued companies as they delay public listings. The market can also be an important source of cash for start-up employees, who receive a large portion of their pay in stock options.

Several new entrants, such as Carta’s private stock exchange CartaX, now hope to formalise the market and capture trading fees that have been spread between dozens of independent brokers.

“There is now, in the past few years, not a push to go all the way back to the days of strict prohibitions on secondary trading, but a push to have more avenues for organised liquidity,” says Cameron Contizano, a partner at law firm Goodwin Procter who works on secondary transactions.

Meanwhile, investor demand has pushed up prices for companies such as ByteDance, SpaceX and Stripe. Barrett Cohn, chief executive of the private securities broker Scenic Advisement, says he advised companies on twice as many secondary transactions in 2020 compared with the previous year. Of the last dozen deals Scenic worked on in the past few quarters, only one resulted in shares being sold at a discount to a company’s most recent stock price, he says.

Competing for business

The rise in trading volumes and the rush to capture the market will shape the way private shares change hands. San Francisco-based Carta, a company best known for selling shareholder management software to start-ups, has become a lightning rod in debates about the market’s direction. Its 45-year-old chief executive, Henry Ward, has set out an ambitious goal to build the “private stock exchange” for tech start-ups.

Ward wants the CartaX marketplace to compete with the Nasdaq exchange, providing a listing venue where companies could potentially stay private indefinitely. The exchange uses an auction model that Ward says will result in superior prices for sellers.

But the project has already drawn strong responses from rivals and market participants. Some brokers and start-ups say CartaX amounted to an attempt to monopolise the market, and the company is naive to think it could unseat public exchanges. Scenic’s Cohn says Carta has made it increasingly difficult for its clients to export their shareholder data for use in other kinds of secondary transactions, such as tender offers.

Marc Andreessen, the Netscape co-founder and Carta board member. Platforms like CartaX may struggle to meet their targets if private companies remain selective about who owns their shares
Marc Andreessen, the Netscape co-founder and Carta board member. Platforms like CartaX may struggle to meet their targets if private companies remain selective about who owns their shares © David Paul Morris/Bloomberg

“We’re not trying to make the New York Stock Exchange go away,” says Kelly Rodrigues, chief executive of the brokerage Forge, which has begun offering software that companies can use to manage secondary transactions. Forge also bills itself as the “stock market for private companies”.

Others say the most desirable start-ups would not want to use CartaX because few private companies want to subject their shares to monthly or quarterly auctions marketed by the exchange.

Eric Folkemer, head of Nasdaq Private Markets, says it has already set up a similar marketplace with price discovery tools for companies such as the workplace collaboration company Asana that want to facilitate trading in their shares before going public.

“We have it,” says Folkemer. “The question is, does the market want it?”

JPMorgan has put its money behind Zanbato, a private share trading system that is taking a different approach from Carta, acting as a central matchmaker for more than 100 banks and brokers executing orders on behalf of clients.

Nico Sand, chief executive of Zanbato, says the exchange has made a conscious choice to focus on trades between large, qualified buyers with more than $100m in assets, who regulators assume have high amounts of financial expertise and require less oversight.

Zanbato has applied for a patent for a trading system with “firm orders”, a legal contract that forces buyers and sellers to transact shares in a private company after they have submitted orders with desired prices and quantities, says Sand.

He says the concept, which is standard in public markets, is necessary for creating efficient trading in private shares. “At the end of the day, it comes down to formalising the market structure in a way it’s not currently formalised.”

Chart showing trading activity on private stock trading platform Zanbato

‘The third configuration’

So far, Carta is the only company that is listed for trading on CartaX. This month, investors purchased almost $100m in shares following the company’s first auctions on the exchange, in trades that valued the company at $6.9bn — more than double the valuation it received from venture capitalists less than one year ago.

Marc Andreessen, the Netscape co-founder and Carta board member, said in a blog post that he would encourage start-ups backed by his venture capital firm Andreessen Horowitz to consider listing on the exchange. He also said the firm would buy shares in companies on the exchange.

“The third configuration — beyond the false binary of simply private or public — is here,” Andreessen wrote.

But Ward has set targets for the exchange that some people familiar with its workings described as overly ambitious.

A SpaceX rocket lifts off from Cape Canaveral, Florida. The company is one of the most active companies in secondary trading and hosts an internal marketplace where employees and venture capitalists can sell stock to invited investors
A SpaceX rocket lifts off from Cape Canaveral, Florida. The company is one of the most active companies in secondary trading and hosts an internal marketplace where employees and venture capitalists can sell stock to invited investors © Craig Bailey/USA TODAY NETWORK/Reuters

Ward told investors he expected CartaX to generate about $1.1bn in annual revenues by 2024, according to a presentation viewed by the Financial Times. Under the most optimistic scenario, the marketplace would bring in $3.9bn in revenues that year, the presentation said. Carta declined to comment for this article.

CartaX charges 1 per cent fees to both buyers and sellers, implying it would need to facilitate about $55bn in trades a year to reach Ward’s expectations.

Those volumes would require about 3 per cent of the shares in all billion-dollar start-ups to change hands every year, according to Financial Times analysis of data from CB Insights, which estimates that 546 “unicorns” hold a collective value of $1.8tn.

Platforms like CartaX may struggle to meet their targets if private companies remain selective about who owns their shares. SpaceX, one of the most active companies in secondary trading, already hosts an internal marketplace where employees and venture capitalists can sell stock to invited investors.

“They have a lot of demand from buyers,” says Hans Swildens, chief executive of Industry Ventures, which has invested in Carta. “The question, like all the other marketplaces, is supply.”

Venture capitalists say the new exchange could also face competition from an unlikely source — special purpose acquisition companies (Spacs), which have recently lured relatively young start-ups to public markets.

CartaX would force companies to share two years of financial statements prepared using generally accepted accounting principles, in order to comply with a securities exemption the exchange is using to allow participation from an unlimited number of accredited investors.

Lawyers and governance experts say the requirement could help solve inconsistencies in information disclosure in private markets. But others say it would be a burden for young companies, which often remain private to avoid sharing their financial information to a broad audience of investors, reflecting a central tension in the market as brokers and traders attempt to capitalise on the surge of interest in secondary transactions.

“The ‘move fast and break things’ culture of start-ups militates precisely against this,” says Diamond at Santa Clara University. “That, to me, is the fundamental paradox here.”



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Buffett warns of ‘bleak future’ for debt investors

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Warren Buffett warned that debt investors faced a “bleak future” days after a sell-off pummelled government bonds and sent reverberations through global stock markets.

The 90-year-old chief executive of Berkshire Hathaway told shareholders in his closely followed annual letter that it was best to eschew the fixed-income market, in which the company is itself a large player.

“Fixed-income investors worldwide — whether pension funds, insurance companies or retirees — face a bleak future,” he wrote. “Competitors, for both regulatory and credit-rating reasons, must focus on bonds. And bonds are not the place to be these days.”

Treasury prices slid dramatically last week, driven by shifts from investors who see faster economic growth taking hold. Optimism around a global expansion has also rekindled concerns about a spike in inflation, however nascent, and the prospect that central banks may have to adjust their stimulative policies.

Many investors had moved to adjust their portfolios before the sell-off in Treasuries this week, buying lower-quality debt that offered higher returns. Buffett warned on Saturday that the move by insurers and bond buyers to “juice the pathetic returns now available by shifting their purchases to obligations backed by shaky borrowers” was a concern.

“Risky loans, however, are not the answer to inadequate interest rates,” he said. “Three decades ago, the once-mighty savings and loan industry destroyed itself, partly by ignoring that maxim.”

The downbeat assessment of the sovereign debt market accompanied Berkshire’s fourth-quarter results, which showed the company’s net profit rose nearly 23 per cent from a year prior to $35.8bn, or $23,015 per class A share.

The rise was propelled by gains on investment and derivative bets, as the broader US stock market advanced in the final three months of 2020. Accounting rules require Berkshire to report changes in the value of its stock investments in companies such as Apple, Coca-Cola and Verizon as part of its quarterly earnings, resulting in big swings depending on the direction of the market.

Berkshire’s underlying businesses showed some resilience towards the end of this past year, with its operating earnings rising just under 14 per cent. For the full year, which included the fallout from the coronavirus crisis, operating earnings fell 9 per cent from a year prior to $21.9bn.

Buffett directed much of the company’s firepower in the fourth quarter to buying back Berkshire shares, spending $8.8bn on its own stock. For the full year, it repurchased $24.7bn worth of its shares. The share buybacks helped reduce Berkshire’s mammoth cash pile from $145.7bn at the end of September to $138.3bn by year end.

The doyen of the investment world used his annual letter to reaffirm his belief in the US economy, telling shareholders that the country had “moved forward” and that they should “never bet against America”.

While he has in the past weighed in on the direction of the country and supported Hillary Clinton’s campaign bid in 2016, he did not address the election of Joe Biden to the White House and only fleetingly mentioned the rift in the country that was laid bare over the past four years.

Buffett said progress towards “a more perfect union” had been “slow, uneven and often discouraging”. But he added that the country would continue to march ahead.

“In its brief 232 years of existence, however, there has been no incubator for unleashing human potential like America,” he wrote. “Despite some severe interruptions, our country’s economic progress has been breathtaking.”



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Chancellor spots break in clouds after Brexit, Covid and battered finances

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Rishi Sunak will next week deliver a Budget in the shadow of a pandemic, in the aftermath of Britain’s painful divorce from its biggest trading partner and with its public finances, on his own account, under “enormous strains”.

But the chancellor, in an interview with the Financial Times, insisted he can see a brighter future and that his second Budget since being appointed last February will help to build a “future economy” characterised by nimble vaccine and fintech entrepreneurs.

Sunak supported Brexit and now has to show it can work. He knows he cannot expect much help from the EU, which has shown no appetite for opening its markets to the City of London, but still insisted Brexit is an opportunity.

He said post-Brexit Britain would be an open country. “It’s a place driven by innovation, entrepreneurship, taking the agility we have after leaving the EU and putting that to good ends, whether in vaccines or fintech,” he said.

Sunak’s Budget on Wednesday will attempt to flesh out the government’s “build back better” slogan; Britain’s successful vaccine scientists and scrappy tech start-up twenty-somethings will be the poster children of this new approach.

While big and profitable companies are expected to face a hefty increase in their corporation tax bills — part of Sunak’s drive to restore fiscal discipline — the chancellor will focus on companies for whom a profit is a distant dream.

On Friday he told the FT he would launch a new fast-track visa scheme to help Britain’s fastest-growing companies recruit highly skilled workers, as part of a drive to build an “agile” post-Brexit economy.

He said he wanted to help “scale up” sectors such as fintech to compete for the best global talent. The new visa system, he added, would be “a calling card for what we are about”.

Next week Sunak will publish a report by Lord Jonathan Hill, Britain’s former EU commissioner, on the City of London’s listings regime, to make it more attractive for fast-growing tech companies.

“We want to make sure this is an attractive place for people to raise capital — we’ve always been good at that,” Sunak said. “We want to remain at the cutting edge of that.”

The chancellor confirmed Hill will look at whether London can be a rival to New York as a location for so-called Spacs, the modish blank-cheque vehicles that hunt for companies to buy and take public.

He declined to speculate on what Hill will recommend, but gave a broad hint he supports radical reform. “Do we want to remain a dynamic and competitive place for people to raise capital? Yes we do,” he said.

The loss of some City business, including EU share trading, to Amsterdam has reinforced criticism of the government over its negotiation of a trade deal that focused heavily on fish, but hardly at all on financial services.

Last summer the Treasury filled in hundreds of pages of questionnaires from Brussels about its regulatory plans for the City but Britain is still waiting for a series of “equivalence” rulings that would allow UK firms to trade with the single market. It could be a long wait.

When Emmanuel Macron, French president, was asked this month by the FT if he was in favour of Brussels granting “equivalence” to UK financial services rules, he replied simply: “Not at all. I am completely against.”

Sunak insisted he has not given up and that the Treasury remained “constructive and open” in talks with Brussels. But he added: “We live in a competitive world. It’s not surprising other people are looking after their interests.”

Sitting in his sparse Treasury office, stripped of any clutter, wearing his trademark bright white shirt, Sunak said: “We just need to focus on what we’re in control of. I’m enormously confident about both the future for the City of London and, more broadly, financial services.”

At the age of 40, Sunak is only just a year into the job. “When I got the job I had three weeks to prepare a Budget,” he recalled. “I genuinely thought at the time it would be the hardest thing professionally I would have to do in my life.” But that was before the full-blown pandemic hit the UK.

“That Budget turned out, probably, to be the easiest thing I did in my first year in the job. It has been a tough year, dealing with something that nobody has had to deal with before. There was no playbook. We had to move at speed and scale.”

His critics argue that handing out £280bn of borrowed money to support the economy may not have been that difficult either — Sunak’s approval ratings remain very high — and that the really difficult bit is yet to come: trying to rebuild the economy and the tattered public finances.

Conservative MPs are anxious that Sunak’s innate fiscal conservatism might lead him to make unwelcome raids on the finances of core Tory voters and businesses, just as the economy starts to reopen.

The chancellor is expected to freeze income tax thresholds, pushing people into higher tax bands as their pay rises. Another “stealth” move — freezing the lifetime pensions allowance at just over £1m for the rest of the parliament — was reported in the Times on Friday and not denied by the Treasury.

And all the while Sunak will carry on running up debts into the summer to protect the economy from what he hopes will be the last Covid-19 lockdown. He said he is “proud” of what the support measures have achieved so far.

“I’m going to keep at it,” he said. “Some 750,000 people have lost their jobs and I want to make sure we provide those people with hope and opportunity. Next week’s Budget will do that.”



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