ETF field getting more crowded

Money managers' battle for ETF market share will be facing two fronts in 2012: new firms entering the market and a bigger-than-ever push into active strategies.

In addition, all eyes are on Pacific Investment Management Co., Newport Beach, Calif., which is seeking to become the first money manager to essentially clone a popular mutual fund into an exchange-traded fund, analysts said.

All want to gain a foothold in the business that is dominated by three players with more than 80% of the ETF market: BlackRock Inc.; State Street Global Advisors; and Vanguard Group Inc.

BlackRock's iShares unit holds almost 43% of the $1.05 trillion North American ETF market, followed by SSgA with 25.3% and Vanguard with 16%. After that the curve drops precipitously; the fourth biggest ETF provider, Invesco Power Shares Capital Management LLC, has only 4.2% of the market.

Of the top three, only BlackRock has an active ETF, and it's just one of the company's more than 200 ETFs.

Executives at iShares, the ETF unit of BlackRock, and SSgA said they plan to launch several active ETF strategies in 2012. Vanguard filed applications for three active ETFs with the Securities and Exchange Commission in 2008, but is still waiting approval.

PIMCO plans to offer an active ETF version of the world's largest mutual fund, the $244 billion PIMCO Total Return Bond Fund. The ETF would be managed by William Gross, PIMCO founder and co-chief investment officer, according to a prospectus filed with the SEC in April.

“The (ETF) version of the Total Return Bond Fund could be a game-changer,” said Paul Justice, director of North American ETF research for Morningstar Inc., Chicago. “It would have brand presence,” he said, adding the ETF could launch as early as January. ”It could change things for the active landscape.”

New entrants with applications for active ETFs before the SEC include Legg Mason Inc., Eaton Vance Investment Managers, T. Rowe Price Inc., Janus Capital Group, Northern Trust Corp., Goldman Sachs Asset Management, J.P. Morgan Asset Management, Federated Investors Inc., AllianceBernstein LP and Neuberger Berman Group LLC.

Fidelity Investments also is waiting for SEC approval, seeking to expand beyond its one passive ETF product.

Consultant McKinsey & Co. said in an August report that more than 800 active ETFs are awaiting approval from the SEC.

And while those firms are waiting for SEC approval, other money managers are expanding their offerings.

Russell Investments, Seattle, jumped ahead of the line when it bought the license of U.S. One Inc., a small ETF provider, in January. Because U.S. One already had received SEC approval for its single active ETF, Russell was able to quickly expand its offerings and in May the company introduced six passive ETFs tied to new Russell indexes.

Russell currently offers 26 ETFs and plans to introduce 10 to 20 new funds a year for the next several years, said James Polisson, managing director of Russell's global ETF business, based in San Francisco. Russell has one active ETF and plans to launch three more in 2012, according to SEC filings.

So far, active ETFs make up only 1% of the approximately $1.5 trillion in worldwide ETF assets, McKinsey said in its August report.

Jim Ross, a senior managing director at SSgA and global head of its ETF business in Boston, said an issue with active ETFs is the lack of a track record. But PIMCO might not be saddled with that problem, given the success of the Total Return Bond Fund. “It could take off quickly,” said Mr. Ross. ”Any investor who knows PIMCO and its track record is going to have confidence from that perspective.”

PIMCO spokesman Michael Reid said executives could not discuss the proposed fund or its ETF business in general.

Morningstar's Mr. Justice said if PIMCO is able to successfully clone the mutual fund, other money managers would likely follow suit.

But significant issues still remain for active strategies to obtain significant market share, particularly for equity offerings, the bread-and-butter of the ETF industry, according to money managers and consultants.

Mr. Ross of SSgA said transparency is key. Active equity managers don't want to reveal their strategies, fearing others will front-run them or copy their investment strategy. The issue is less bothersome for fixed-income strategies, which are harder for investors to duplicate, he said.

Filings show BlackRock submitted an application with the SEC in September for exemptive relief to be able to offer a broad range of actively managed ETFs that would not divulge holdings each day. BlackRock instead wants to disclose the holdings monthly or quarterly.

Darek Wojnar, a BlackRock managing director who is the head of iShares product development in San Francisco, said he could not discuss the company's plans while the application is pending. But he did say the iShares unit plans to introduce a few active strategies in 2012 that would be fully transparent while it continues to seek approval from the SEC to offer a broader array of active products with modified disclosure rules.

Mr. Ross said SSgA will offer active strategies in 2012 that will enable investors to buy an ETF composed of other ETFs, similar to a fund-of-funds strategy. The money manager also plans to introduce an actively managed bank loan product ETF that will be subadvised by GSO/Blackstone Debt Funds Management LLC.

Not all managers who filed to offer ETFs want to enter the market. They could feel forced to act as their competitors get into the game, said Geoffrey Bobroff, president of money manager consultant Bobroff Consulting Inc. in East Greenwich, R.I.

Mr. Bobroff said he was particularly surprised by Fidelity's Dec. 1 SEC filing seeking to offer equity and fixed-income index-based products. Fidelity has only one small ETF, which it has not heavily promoted. “It's probably more an offensive move than not,” he said of Fidelity's filing.

Fidelity spokeswoman Sophie Launay declined to elaborate on potential ETFs. “We are always looking for new ways to serve our clients,” Ms. Launay said.

Legg Mason, Baltimore, meanwhile, expects to offer a broad line of active fixed-income and equity ETFs in the next few years, said Bill Golden, a managing director and head of U.S. products. Those ETFs will draw on the investment expertise of the company's seven investment subsidiaries.

“We're looking for quality, not quantity,” he said. “We aren't looking to throw a bunch of strategies against the wall and see which one sticks.”

The company filed documents Nov. 23 with the SEC detailing its first offering, a short-dated bond ETF. It will be managed by Western Asset Management Co., Legg Mason's fixed-income subsidiary in Pasadena, Calif. Mr. Golden said the money manager hopes approvals for the product could come in the next 10 to 12 months.

Mr. Golden said he expects Western's reputation will give investors the confidence to skip the normal three-year track record needed to garner sufficient resources.

Just how many ETFs launch in 2012 will largely depend on how long the approval process takes at the SEC. Some money managers have been waiting for a year and a half or more for SEC action. An SEC official who would only talk on background said the more complex or novel products are going through a more thorough review than other offerings.

Money manager Eaton Vance has filed with the SEC to launch a hybrid — exchange-traded managed funds. President and CEO Tom Faust said in an interview a managed fund would be similar to a traditional active mutual fund because it would be sold at net asset value and would be managed by portfolio managers. But the products also would contain ETF characteristics, such as trading on exchanges and in-kind creation and redemption of shares, he said.

“We think this could replace mutual funds,” he said.

Mr. Faust not only wants Eaton Vance to sell its own funds, but also wants to sell licensing agreements to other money managers.

Just how big could the ETF industry could become is an open question. In its report, McKinsey said ETF assets worldwide could grow to between $3.1 trillion and $4.7 trillion over the next five years — from about $1.5 trillion now — as they become more visible to investors. “Awareness and adoption of ETFs will continue to rise as more well-recognized fund names enter the market with both passive and active ETF products,” the report said.

Not everyone agrees with such optimistic projections. Mr. Bobroff said the inflows seem to have leveled over the past 18 months, with some outflows in equity ETFs. He said new product launches should help, but not to the extent predicted by McKinsey.

Consultants to institutional investors say there is a strong appetite for ETF fixed-income products among investors, but that equity ETFs have fallen out of favor as stock markets have declined.

Total equity ETF net inflows dropped to $743 million in the third quarter from $15.4 billion in the second quarter, according to data from SSgA and Bloomberg.

November ETF flow numbers released by SSgA show $475 million in net outflows industrywide for the month. The biggest loser was large-cap equity ETFs, with net outflows of $7.3 billion. Fixed income continued to see positive inflows, attracting $5.1 billion in November.

The decline in equity strategies is not good news for the ETF industry, since equity products make up the largest group, $624 billion of the more than $1 trillion of ETF assets, the data shows.

The McKinsey report acknowledged issues that could hamper the market's growth. One is the rapid increase in products, coupled with a rising number of failed launches, which “suggests that the passive ETF market is getting closer to saturation.” In 2009, nearly three-quarters of all launches “failed” — meaning they did not gather significant assets within two years — compared with less than a 10% failure rate for those launched in 2003, the report said.

Onur Erzan, a partner with McKinsey in New York, said ultimately he sees three to five large players and three to five midsize players dominating the industry, although there will be room for another 12 to 24 to make their mark. He wouldn't name any firms.