Exchanged traded funds are poised for additional growth, driven by relentless competition among firms and a streamlined regulatory environment.
Exchange-traded funds, which have existed for just over a quarter century, have indeed come of age as an investment product. With approximately $4 trillion in assets under management and more than $1 trillion in net inflows over the past three years alone in the United States, ETFs have been propelled by the rise in popularity in passive investing over active investing.
Yet the industry is poised for even more growth, driven by relentless competition among firms and a streamlined regulatory environment.
The recent elimination of trading commissions by online retail brokerage firms should also spur more active interest in ETFs. The days when the ETF market was dominated by simple baskets tracking broad-based indices are quickly receding. Today, more complex products give investors exposure to sophisticated trading strategies. This makes those products a viable option, even for institutional investors, to express dynamic investment mandates.
In addition, the passage of the Securities and Exchange Commission’s Rule 6c-11 in September 2019 is expected to make it easier for ETF providers to launch new products by reducing the time and cost involved. The rule will also enhance disclosure requirements and improve transparency for investors.
Despite the rise in exchange-traded products, middle market players have lost ground as the largest ETF providers increasingly capture the lion’s share of the industry’s business.
Top 10 US ETF providers make up more than 90% of the total AUM
Source: Bloomberg, RSM
Competition to offer low-cost products will continue to make it challenging for middle market players. New products that do not quickly scale to the critical mass needed to defray operating costs and establish market recognition often fail to survive. Nonetheless, middle market participants can still compete in this market.
Be different, be first
Despite the expansive menu of ETFs now available, innovation and differentiation can still yield success if the product can gain market penetration before other firms launch competing products. New investment themes emerge regularly, and the ability to structure products to cater to these and come to market quickly can give first-mover advantages. But even within a competitive landscape, differentiation may still be achieved by overlaying a focus on investment objectives that are now gaining more interest such as environment, social and governance themes.
In a world in which investors now use algorithms and screens to determine where to put their money, middle market asset managers should not underestimate the importance of designing and marketing products with this in mind. New products that can be clearly categorized in the sea of ETF products increase the chance for discovery.
Technology is not just for the big guys
The ability to price products at the lowest cost possible without creating operational and compliance risks can often be a challenge for middle market players. They simply have not had the ability to invest in technology on the same scale as their larger competitors. But this is changing as computing power becomes cheaper and more available on demand through outsourcing and other creative solutions. Middle market players should explore these solutions to enhance their capacity to compete on price and capture their share of the gains that are set to continue in the ETF market.