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ETF business opportunities are rapidly expanding as new generation of funds emerge, says SEI

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Twenty years after their introduction, Exchange Traded Funds (ETFs) are evolving and gaining momentum more rapidly than in the past, according to the report by SEI.

The report – ETF 2.0: Six Trends Shaping the Next Generation – dentifies six trends that could help push ETF assets to a projected USD5 trillion by 2020. According to ETF.com, U.S.-listed ETF assets reached a record USD2 trillion at the end of 2014 with record annual inflows of USD244 billion. Flows to European ETFs also hit a new peak, rising to USD61.4 billion for the year, more than three times the 2013 total.

“What started as a relatively simple, index-based product is now taking on new forms, penetrating new markets, and expanding its distribution channels,” says John Alshefski, Senior Vice President and Managing Director of SEI’s Investment Manager Services division. “The industry is evolving on all fronts at once, making a leap much like the one that took the Internet from static pages of text to the interactive, graphics-based Web 2.0 environment we operate in today.”

The six trends discussed in the ETF 2.0 report include:

Active ETFs – After much anticipation, actively managed funds are finally moving from “vaporware” to reality as regulators and ETF sponsors find new ways to address transparency issues. This category also includes “smart-beta” funds, passive/active hybrids that use factor-based indexing to enhance returns – which have doubled in number over the last five years.

Ongoing convergence of mutual funds and ETFs – These two worlds increasingly intersect as new product types emerge, investment organisations seek to package their strategies in varying formats, and investors utilise both product types side by side. The study points out that many mutual funds employ ETFs to implement their strategies.

Widening appeal – First adopted by institutional investors, ETFs have been broadly embraced by advisors and intermediaries. ETFs are beginning to penetrate retirement plans as well as the retail market, where they are especially suited to fee-based advice environments.

The emergence of strategists and robo-advisors – The industry’s growth has spawned a new type of advisor, ETF strategists, who actively manage separate accounts using ETFs. Such firms already manage close to USD100 billion in the US market alone, according to Morningstar estimates. Also likely to be steady users of ETFs are the new breed of online advisors dubbed “robo-advisors,” which bring a high degree of automation to the asset allocation and investment processes.

Education-focused marketing – New product types and distribution channels only compound the need to educate investors about the workings and performance of ETFs. For example, investors should know that different approaches may produce widely varying results, even if they start with the same index. The industry should also address the various roles ETFs can play in investor portfolios, as well as the risks involved in misusing them.

Global opportunity – To date, ETF growth has been the most rapid in North America. However, ETF adoption is accelerating in both Europe and Asia, with non-US markets totalling more than USD760 billion, 29 per cent of the global total.

The report states that ETF providers and new entrants will need to overcome a number of challenges relating to distribution, sales efforts, and the complex operational demands intrinsic to the vehicle in order to fulfil the opportunity currently unfolding. 

“Unlike mutual funds, ETFs must deal with in-kind transactions on a daily basis, continually update their portfolios in real time, and accurately disclose their holdings at the end of each trading day. With active ETFs, the demands are even greater,” says Rob Owens, Strategic Relationship Manager of SEI’s Investment Manager Services division. “To avoid alienating the authorised participants who trade in their funds, ETFs must have an operating platform with data management capabilities tailored to their needs. They also need service providers with specialised expertise in ETF distribution, tax, legal, and compliance issues.”

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