Although an oligopoly of three money management firms dominates 84% of the U.S. market for exchange-traded funds, the relative newcomers to this fast-growing investment segment are capitalizing on their brand names and existing strengths as competitive advantages.
Pacific Investment Management Co., Charles Schwab & Co. Inc., Northern Trust Corp. and other investment management firms that compete for the remaining 16% of the marketplace have been able to increase assets by ignoring for the most part the core ETF products following popular indexes that are some of the hallmarks of the top three providers. Instead, the newer competitors have developed their own unique offerings, such as an ETF following a custom index designed to track diversified commodity exposure in the case of Northern Trust or an ETF version of the world's largest bond fund in the case of PIMCO, said Ben Johnson, director of passive fund research at Morningstar Inc. in Chicago.
Mr. Johnson said it would be difficult to compete with the big three on core ETFs.
“They have a stranglehold on those products,” he said.
Total ETF assets in the U.S. are still small, $1.4 trillion, when compared with mutual funds at $9.6 trillion. But for many major diversified money management firms, having an ETF lineup is important, particularly if the segment starts heating up and becomes bigger, said mutual fund consultant Geoffrey Bobroff, president of Bobroff Consulting Inc., East Greenwich, R.I.
Mr. Bobroff said that generally an ETF has to gather between $50 million and $100 million in assets to become profitable. Companies like PIMCO, Schwab and Northern Trust don't break down revenue or profits or losses for their ETFs.
BlackRock Inc., New York, the largest ETF provider in the U.S. with $566 billion, reported 29.5% of its $9.34 billion in revenue came from its ETFs in 2012. It does not break out ETF profits.
Broadly speaking, ETFs can be more profitable than mutual funds for money management firms, said Jason Weyeneth a New York-based analyst with brokerage firm Sterne Agee Group Inc. Mr. Weyeneth said most ETFs follow passive indexes, so once the index is set up, the ETF does not have the cost associated with paying active managers.
Mr. Weyeneth said Invesco Ltd. reported operating margin in the mid-30% range in 2012 but noted in its financial statements that its PowerShares ETFs achieved or exceeded that operating margin range. Invesco PowerShares is the fourth largest ETF manager in the U.S. with $62 billion in assets.
Another window into ETF profitability can be found by looking at WisdomTree Investments Inc., New York, the sixth largest ETF provider with $26.3 billion in assets under management. It reported net profits of $11 million in 2012.
Mr. Weyeneth said WisdomTree has an operating margin in the mid-20% range, but estimates that if the company can achieve $35 billion in AUM, it can bring profitability up to at least 40%.