The ETF space has seen an impressive influx of capital; those in the US raked in a total of US$295 billion in 2018, which research firm XTF says has brought assets to roughly US$3.4 trillion. That’s a fraction of the US$18.7 trillion in mutual funds, but the shift in investors’ preferences is undeniable.
But with a new year comes new expectations, and the expectations aren’t so great for the industry as it begins to mature. One outlook held by Robert Tull, president of Procure Holdings in the US, sees a continued race to the bottom in fees on individual ETF offerings, particularly among large issuers and asset managers who can “find revenue other ways.”
Citing data from XTF, the Wall Street Journal said ETFs with expense ratios below 0.2% captured 95% of net flows last year; currently, they hold 72% of industry assets. US equity has been the hotbed for fee conflict, but it’s spreading to international and fixed-income funds as well as specialty mandates such as those focused on gold and ESG investment. Dave Nadig, managing director of ETF.com, also sees advisory fees facing added pressure as investors weigh robo-advisor or similar low-cost services offered by major brokerage firms.
The wave of new products, coupled with moderating institutional support, has also meant more funds are sitting with low asset levels, said FactSet’s director of ETF Research Elisabeth Kashner. Focusing on ETFs launched from 2007 to 2016, she said 45% of funds that failed to cross the US$50-million AUM line by the end of their first year on the market have closed, and another 30% still haven’t reached that milestone. Institutional investors have more leverage to trade in and out of smaller funds; individual investors and advisors, on the other hand, often contend with challenges like lower liquidity and higher trading spreads when it comes to smaller products.
And just as most smart-beta or factor ETFs faced their first bouts with volatility and drawdowns last fall, this year could test the mettle of more marginal products that “a lot of investors don’t understand very well,” said Jeff Tornehoj, director of fund insights for Denver-based Broadridge Financial. He expects investors large and small to be “cautious and deliberate in their uptake” of sector and geography factor funds, multifactor products, and other unfamiliar strategies. This assessment will likely be made as money moves from active equity mutual funds, for which Morningstar saw US$182 billion in withdrawals for the one-year period ended in November 2018, to alternatively weighted equity ETFs, which XTF says saw US$76 billion in net new assets.
While the pace of issuances and closures has been of great interest to observers of the space, Daniil Shapiro of Cerulli Associates is putting more stock in the degree of differentiation. “Competing with BlackRock and Vanguard for core products will get even more challenging, but there is significant room to differentiate with alternative offerings,” said the firm’s associate director of product development.
As ETF assets stay on pace to reach US$17 trillion by 2030, he expects more differentiated products from smaller asset managers, insurance providers, and advisory firms. Self-indexing is another trend to watch as more issuers consider forgoing the cost of licensing a benchmark from providers like S&P Dow Jones Indices, MSCI, or FTSE Russell by engineering customized investments for institutional investors.
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