The era of seemingly constant and endless growth of the $2 trillion exchange-traded product universe in the U.S. might be waning. Market leadership among issuers is consolidating. New products and entrants are leaning heavily on broad distribution and brand awareness.
Yet, when it comes to sparking institutional interest, “there's nothing better than a track record,” says Adam Patti, chief executive officer of Rye Brook, N.Y.-based IndexIQ, which is in the process of being acquired by New York Life Investment Management. Part of another trend as the product category matures, IndexIQ is among several ETP-focused issuers or service providers that have been scooped up in recent months.
“Because exchange-traded products are a more asset-light model for issuers, the barriers to entry are extremely low and the barriers to success are extremely high,” says Ben Johnson, global head of passive research at Morningstar Inc. , Chicago.
Outside of acquisitions — which include the completed or pending purchases of Velocity Shares by Janus Capital, ETF Issuer Solutions by Virtus Investment Partners, and Dorsey Wright Associates by Nasdaq — signposts of a maturing industry have also appeared at the top of market.
With $450 billion in ETF assets under management, according to research firm XTF Inc., Vanguard Group, which boasts lower expense ratio than most other issuers, recently passed State Street Global Advisors as the second-largest issuer in the U.S. market. In early February, SSgA announced expense ratio reductions on 41 of its smaller products by assets under management. Similarly, the iShares unit of BlackRock in June 2014 doubled the funds in its low-priced Core lineup to 20.
Recently, Fidelity Management and Research Co., which has a marketing agreement to offer 70 iShares funds to its customers with no commission, has shown what a large asset manager can do with embedded distribution and marketing.. In just 18 months, investors directed nearly $2 billion to 13 of Fidelity's recently launched sector equity and fixed-income funds, according to XTF Inc. (Fidelity also has managed a $553 million Nasdaq Composite tracking fund since 2003.)
This model for retail and adviser distribution follows closely the path set by Charles Schwab Corp., which has climbed to $29 billion in ETF assets under management in little more than five years. As a fund broker, Schwab has also setup a commission-free platform, known as ETF OneSource, in which other issuers can offer their products to Schwab's customer base commission free. While fund issuers pay for this “shelf space” at Schwab, fees are not paid directly by the funds.
“The toll is markedly less than inclusion on Schwab's mutual fund platform, but it is an impediment to expenses going lower for those funds,” says Morningstar's Mr. Johnson. Building scale to ultimately lower fund cost is not only about the assets in the funds, but also about the scale of the issuer. For example, in December, Victory Capital Management, Brooklyn, Ohio, announced that it was buying Compass Efficient Model Portfolios, Brentwood, Tenn. No terms were disclosed.
According to Stephen Hammers, Compass chief investment officer, working with Victory will allow the firm to significantly cut its expense ratio to be more competitive with other ETF issuers of alternatively weighted index funds. Compass EMP manages $1 billion in traditional and exchange-traded funds, including five ETFs with $161 million in assets under management.
IndexIQ's Mr. Patti says his firm's pending sale to New York Life Investment Management benefits both companies. IndexIQ, which specializes in hedge fund-like strategies using existing ETFs, gains a distribution partner and New York Life gains a business unit through which to offer ETFs from several of its other brands, including Mainstay Funds.
“Our distribution strategy had focused on RIAs and more sophisticated financial advisers, but we are beginning to hear more from institutional consultants and managers,” he said. “We put all of resources into research and never really had sales and marketing resources. To have the capabilities of New York Life's distribution and brand will give investors even more comfort on our products and infrastructure.”
“Small firms like ours have to compete with managers with dozens or even hundreds of salespeople and millions in their advertising budget,” says Mebane Faber, co-founder and chief investment officer of Cambria Investment Management Inc., El Segundo, Calif., which manages $390 million in ETF assets.
Mr. Faber, who previously managed an ETF under the AdvisorShares brand, has taken a very entrepreneurial approach to marketing and communicating his investment strategies. A frequent publisher, blogger and speaker on investment strategies, he has built himself up as a microbrand alongside the asset management business. n
