Over the past two decades, the ETF industry has grown to asset levels that few predicted when the first U.S.-listed ETF was launched in 1993. In its early stages, the ETF industry offered only a handful of funds that tracked prominent domestic equity indexes. Today, exchange-traded products (ETPs—including ETFs, ETNs and other exchange-traded structures) offer liquid, low-cost exposure to a wide range of additional asset classes, including international equities, fixed income securities, commodities and currencies, along with a variety of sub-categories within each of these asset classes. This year, we expect the number of ETPs listed in the United States to exceed 1,500, with over $1.2 trillion in assets under management, which raises the question: How much capacity exists for future ETP industry growth?
To answer this question, we can start by looking back at historical growth rates of ETP industry assets under management. Over the past 10 years, ETP assets have grown at an annual rate of about 30%, despite the fact that equities, which represent the largest group of ETP assets, essentially moved sideways during the same time period. During the last five years, this growth rate slowed to about 22%, which is understandable considering the timing of the financial crisis and its effects on equities and other risky assets from late 2008 to early 2009. Over the past three years, asset growth has reaccelerated to an annual rate of about 25%. Whether or not ETP asset growth continues to accelerate at these robust historical rates or begins to level off will largely depend on a few key factors.
Underpinning historical asset growth has been the ability of ETPs to expand into new, untapped asset classes. As domestic equity ETPs lost ground a few years ago, ETPs in other asset classes, such as fixed income, experienced increased demand. Today, only four of the 10 largest ETPs track U.S. stocks. In fact, even as domestic equity ETPs have recovered over the past three years, net inflows for this category have trailed behind both international equity ETPs and fixed income ETPs. Commodity ETPs have also received strong inflows. Without the inclusion of these additional asset classes, the ETP industry would be less than half its current size. While most of the low-hanging fruit has already been gathered, future asset growth will depend partly on how successful ETP sponsors are in introducing additional asset classes into exchange-traded products.
Because there are fewer unexplored asset classes remaining, the next wave of ETP innovation will likely focus on fine tuning exposure within asset classes. One case in point over the last few years has been the surge in issuance of new equity income ETPs. These funds, which diverge from traditional market-cap weighted indexes in order to provide conservative, dividend-focused strategies, have been successful in gathering new assets even as broad domestic equity index ETPs faced net outflows. Another example of product innovation within an existing ETP asset class is the introduction of various strategies by which commodity futures ETPs seek to minimize the potentially negative impact of rolling from one month’s futures contract to another. In order to maintain asset growth trends during the next decade, ETP sponsors must continue to seek new and better ways to provide exposure to a variety of asset classes.