No Slowing of ETF Growth, Just New Areas to Grow Into

One thing was certain at Morningstar's ETF conference: The ETF growth train doesn’t seem to be slowing down and more firms want to climb aboard

ETF industry assets under management have grown from $800 billion in 2010 to more than $3 trillion in 2017, most in net new cash flows. Passive indexing has been welcomed with opened arms by the advisory business, in creating, distributing and purchasing product in a more cost efficient way. This year, the seventh year of its ETF U.S. conference, Morningstar said it had 714 attendees vs. last year’s count of 660 (not including staff of the 25 sponsoring companies), and perhaps in a nod to the mainstreaming of these products, the firm has decided to merge the ETF U.S. conference into its larger investment conference next June, giving ETFs their own track.

It was apparent that passive indexing is still king and low fees are the key attraction to users. As one sales representative said: “Price is the new performance.” Yet other changes are making their way into the business. More investment firms are entering it by launching active management and strategic or smart beta indexes and products to meet new demand. Others see socially responsible ESG products as a core area of growth, and all believe education is necessary to keep up with the interest.

The immense growth of these products isn’t a surprise to Fran Kinniry, a principal of Vanguard, who noted that the distribution method of ETFs has been a major attribution and changed the entire investment industry.

And though compression of fees was the buzz, apparently that hasn’t frightened new entries away from launching new ETFs. For example, OppenheimerFunds, which historically is known for its actively managed funds, entered the smart beta ETF business by purchasing VTL Associates in 2015, while in 2016 Columbia Threadneedle purchased Emerging Global Advisors LLC and its smart beta products based on emerging markets. Other firms, like Franklin Templeton, built out their own ETF business. In addition, firms are breaking down smart beta into separate factors, such as low volatility, momentum, quality and value.

Compared with mutual funds, even actively managed or smart beta funds are relatively inexpensive. While Fidelity’s passive funds charge an expense ratio of 0.084% (0.21% on the Nasdaq Composite ONEQ), its smart beta ETFs come in at 0.29%, while actively managed ETFs have an expense ratio of 0.45%.

Ken O’Keeffe, FTSE Russell managing director of global ETFs, agrees there has been growing interest in smart beta products. In addition, he’s seen a big move of interest and need for fixed income ETFs. In May, FTSE Russell’s parent, the London Stock Exchange, announced it would purchase Citigroup’s fixed income analytics platform and index business. Today FTSE Russell has about $550 billion in assets in ETFs, he says.

“There’s also been a big trend in providers broadening their offerings,” he says. He points out that by providing all levels of products — passive, active, smart beta as well as equity and fixed income — it provides “one-stop shopping” for investors. He added that the purchase of Citigroup’s analytics platform brought an educational component to the business, which he sees becoming necessary as advisors clamor to understand differences and uses in all the products.

Mannik Dhillon, president of VictoryShares and Solutions, which has $1.8 billion in ETFs, says the growth in smart beta will continue. “There is a definite trend that has emerged and will continue, and it’s not going to mean ‘beta products,” he says. “That’s where industry began, that’s where assets are … but what existing ETF owners will begin to realize is [beta products] aren’t a strategy or an asset class,” he says. “There is an opportunity to outperform traditional beta by being different from the benchmark, thus being active … So the world’s going to see they can be different from the benchmark in a rules-based way, and potentially get excess return or lower risk or both. Maybe it is more expensive than they pay for traditional beta, but it’s a third of what they were paying for with active.”

Bottom, line, he says, “It’s not all or nothing. These are all valuable tools that can deliver.”

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