European fund performance significantly lags behind US peers after T+1 #NewsMarket

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Lower returns for European funds investing in US equities compared with US-domiciled funds with similar portfolios are accelerating demand among asset managers for the EU to cut fund settlement times.

Ignites Europe analysis of Morningstar data suggests the change may be having a negative effect for European investors, bearing out warnings from asset management executives on differences in settlement times between Europe and the US.

Average total returns for Europe-domiciled funds investing in US equities are lower than for US vehicles in the same asset class since settlement cycles were reduced in the US from two days after the trade date (T+2) to one day, or T+1.

This finding is also shown when comparing the smaller universe of passive funds tracking the S&P 500, where EU-domiciled funds have posted lower average returns than US products since the settlement time cut on May 28.

This article was previously published by Ignites Europe, a title owned by the FT Group.

Total returns for EU-domiciled S&P 500 tracker funds and ETFs between the T+1 start date and the end of July have been 14 basis points lower than the returns for US-domiciled products, at 4.14 per cent and 4.28 per cent respectively.

Using weekly return data to August 3, there is a difference of 20 bps between the two groups of funds.

By contrast, over the past one and three years, US-based funds tracking the S&P 500 have performed slightly worse on average than equivalent products in Europe.

While not conclusive, the data suggests that the change to T+1 is having a negative impact on European funds and their clients, as experts have feared.

A person working for a large asset manager, speaking on condition of anonymity, said “it is more expensive to operate and trade in Europe” since the US moved to T+1.

The person said this affects exchange traded funds and other products, particularly at firms with less of a global presence that cannot easily switch processes to non-European jurisdictions.

Jim McCaughan, US practice leader at Indefi, an asset management consultancy, said that “there will be a measurable drag on performance” due to settlement misalignment between the US and the EU, depending on the strategy and accounting method deployed by the fund.

McCaughan said misalignment between buying and selling cycles for US and European equities could require a fund to borrow money to cover funding gaps or to get a broker to settle on a later cycle, which would incur a fee.

EU policymakers are currently considering whether the bloc should follow the US in cutting settlement cycles from T+2 to T+1.

The misalignment between settlement cycles in the EU and US has been blamed for increasing trading costs for European fund managers, which ultimately dampens returns for investors in the bloc.

The European Securities and Markets Authority is expected to publish its recommendations on whether the EU should move to T+1 in the coming months ahead of a potential 2027 switchover.

Vincent Ingham, director of regulatory policy at the European Fund and Asset Management Association, told an Esma hearing last month on a potential EU switch to T+1 that “the current misalignment is producing a substantial cost factor for the European buy side that deteriorates the performance of our funds”.

Ingham told the hearing that this lower performance would be “ultimately borne by end investors”.

Adrian Whelan, global head of market intelligence at Brown Brothers Harriman, added that increased trading costs for EU funds following the US move to T+1 is “one of the reasons why European T+1 is so critical — it would remove this funding gap instantaneously”.

Whelan said that while T+1 cannot be said to have “definitively” reduced EU fund performance, “there are two trading cost dynamics that are increasing general trading costs for non-US managers attributable to T+1.”

He said a tightening of trade affirmation deadlines to 9pm US eastern time on the trading date means “if a trader misses this deadline, the trade [gets] put into a later batch for processing”, which “costs more to settle and [can] spike as trade volumes increase”.

Whelan added that “unusual trading patterns” have arisen on Thursdays when trading US securities becomes more expensive as trades must be hedged for a three-day period over the weekend after settling on Friday.

This creates higher margin requirements for brokers, who then charge higher spreads to handle these obligations, further reducing liquidity in the market.

“This funding anomaly arises especially on European funds where investor subscription and redemption cycles are generally still T+2,” said Whelan.

Additional reporting by Ed Moisson

*Ignites Europe is a news service published by FT Specialist for professionals working in the asset management industry. Trials and subscriptions are available at igniteseurope.com.