Exchange-traded fund assets increased at a compound annual growth rate of 21 per cent during the five years ended 2017, growing to USD3.4 trillion, before taking a pause in 2018 due to an equity market decline.
While Cerulli Associates expects the ETF industry to continue to grow, the research and consulting firm is cautioning against extrapolating from historical flows and market returns, according to a new report, US Exchange-Traded Fund Markets 2018: Innovating for the Investor.
The rapid growth of the US ETF industry appears improbable when considering the challenges associated with product-specific distribution features. Issuers rate home-office approval (90 per cent), accurately and fairly incentivising wholesalers (90 per cent), and payment for distribution (86 per cent) as top challenges to asset growth. Furthermore, as wirehouses and broker/dealers increasingly move toward fewer, deeper relationships with their asset manager partners, product rationalisation and the culling of products available in models and on platforms will likely continue. ETFs are not exempt from these culls, which to this point have focused on products that have not accumulated significant assets or do not fit into long-term strategic holdings.
“Issuers consider being featured on key platforms across wirehouses, broker/dealers, and home offices a top priority and landing a product within a home-office model as the ‘holy grail,’” says Daniil Shapiro, associate director. “Winning a sleeve in a model helps generate significant assets, especially as more financial advisors move into fee-based accounts. However, not having enough assets to begin with makes it difficult to win shelf space on a platform.”
Increasingly, issuers are also relying on strategic beta and actively managed ETFs for revenue generation. While fixed-income managers appear willing to make their active strategies available in a transparent structure, equity managers are largely awaiting regulatory approval for additional non-transparent ETF structures. A key question is whether ETF buyers such as advisors and strategists will be interested in a non-transparent ETF structure even if one is approved. Issuers are also evaluating self-indexing from a cost savings perspective, but Cerulli cautions that that while the strategies can be an opportunity to create unique products based on firm expertise, they can also face barriers to growth and present conflicts of interest.
“The ETF industry has flourished by challenging market convention, particularly the necessity for expensive active management, by providing low-cost passive, transparent, liquid, and tax-efficient investments in an easily accessible wrapper,” says Shapiro. “As issuers search for new drivers of growth, innovation can push trade-offs in the features that made ETFs successful products. Issuers will need to strategically assess the viability of ETF variations and whether or not they support the spirit of the ETF industry and provide value to investors.”