Russell and Scottrade reconsider ETF market

Smaller ETF players struggle to compete with BlackRock, SSGA and Vanguard

Exit sign

The ETF Big Three's stranglehold on the industry is finally starting to make some smaller players bow out and could lead to more mergers and acquisitions.

The dominance of BlackRock (BLK) Inc. (BLK)'s iShares, State Street Global Advisors and The Vanguard Group Inc. when it comes to exchange-traded funds is nothing new. Combined, the three firms hold $1 trillion of the $1.2 trillion in all ETFs.

And they show no signs of slowing down.

Those three firms received $70 billion of the $96 billion, or nearly three of every $4, invested in ETFs through the end of last month, according to Morningstar Inc. That put them on pace for their best year since at least 2009.

Last year, the three took in a combined 66% of net inflows, and in 2010, they had 71% of the inflows.

“The larger ones out there had the first-mover advantage,” said Mike Rawson, an ETF analyst at Morningstar. “Now they have the assets and the trading volume.”

Last week, Scottrade Inc. and Russell Investments both said they are pulling back from the ETF industry as a result of a lack of investor interest. The two firms have about $100 million in ETF assets each.

Scottrade will be liquidating its entire lineup of FocusShares ETFs this month.

Russell is conducting a strategic review of its ETF lineup, which may result in the closure of the unit.

“Both firms had good brand names and some distribution experience,” Mr. Rawson said.

“It's sort of disappointing that they both only gave it a little over a year,” he said. “I don't think that was enough time.”

Garrett Stevens, chief executive of Exchange Traded Concepts LLC, an ETF advisory firm, said that there just isn't room to compete when it comes to broad ETFs.

“Growth is going to come from niche products at this point,” Mr. Stevens said.

Those products take time to catch on, though, Mr. Rawson said.

The Russell ETFs, for example, are primarily quantitative strategies that seek to outperform.

“It wasn't proven they were going to work,” Mr. Rawson said. “It's almost like with active management, you need a three-year track record.”

Smaller firms generally don't have that kind of time to wait. As a result, Mr. Rawson and Mr. Stevens anticipate there will be more mergers and acquisitions between ETF firms and traditional asset managers.

Acquisitions could be a way for traditional asset management firms to sidestep the crowded registration process at the Securities and Exchange Commission. It can sometimes take a year or more to get the green light from the SEC to launch ETFs.

Jason Kephart writes for InvestmentNews, a sister publication of Pensions & Investments.