The recent Inside ETFs conference attracted more than 2,200 attendees who soaked up three days of non-stop ETF action, including tips on how to launch an ETF; smart-beta, fixed-income and sector strategies; and interviews with industry leaders on how they are adjusting and adapting their businesses.
Yet despite the ever-increasing use of ETFs and the seemingly constant flow of new assets over the last several years, the 10th annual conference in Hollywood, Fla., featured a somber undertone: the fact that a combination of better technology and price competition has crowded out early adopters — financial intermediaries known as ETF strategists — and erected significant barriers for all but the most financially capable, and willing, investment firms to compete.
According to Elizabeth Kashner, director of ETF research for FactSet Research Systems Inc. Norwalk, Conn., net flows into exchange-traded products in 2016 were a record $284 billion, and total assets across nearly 2,000 products in the U.S. sat at $2.65 trillion. Yet, 64% of 2016 flows went to products costing 0.15% or less, a price point held by “plain vanilla” index funds from BlackRock Inc., Vanguard Group and State Street Global Advisors or products promoted primarily by Fidelity Investments or Charles Schwab on the strength of their retail and financial intermediary brokerage platforms.
Several firms offered highly optimistic outlooks for ETF asset growth, including David Nadig, CEO of ETF.com, who expects ETF assets to top $12 trillion by 2025 and surpass mutual fund assets. But he also highlighted that “even ETFs themselves got Amazoned,” as expense ratios have collapsed for market-leading funds by more than 80% over a decade.
Passively managed mutual funds and ETFs gathered $505 billion in assets, while active strategies saw $340 billion in outflows. And the leading fund complex for active inflows was Vanguard with $20.4 billion, according to Morningstar Inc.
The much-marketed smart beta investing trend also hit a speed bump in 2016. The strategies captured 19% of ETF flows in 2016, down from 22% a year earlier, according to FactSet. Smart-beta funds closed year with $565 billion in assets under management, with the largest flows going primarily to low-cost value funds from BlackRock and Vanguard.
The tough and perhaps saturated product market, however, hasn't deterred innovation.
NextShares Solutions LLC, a unit of Eaton Vance Corp., continued to sign on partners for its exchange-traded managed funds, which trade and settle based on net asset value. While the company counts 15 fund sponsors as licensees, only seven ETMFs have launched since February 2016 from three managers, and assets and trading have been minimal. The firm is also looking to leverage distribution from UBS Financial Services Inc. to bring on more managers.
One of the greatest pain points in ETFs for both asset managers and investors is the challenge of supporting a product with both sufficient assets and appropriate trading volume and tight spreads. As such, 35% of current ETPs hold less than $25 million in assets and the median product only trades $416,000 worth of shares per day.
Despite nearly 60 new issuers entering the market in the past five years, according to Credit Suisse Group analyst Victor Lin, only four have eclipsed the $1 billion asset level across their product set, including J.P. Morgan Asset Management and Goldman Sachs Asset Management.
To counter these challenges, Christian Magoon and John Phillips, ETF industry veterans who lead Amplify Investments LLC., Downers Grove, Ill., believe they have a solution for the challenges of launching and maintaining new products that currently require at least $2.5 million in seed capital and market-making support.
In late January, Elkhorn Securities LLC filed with the Securities and Exchange Commission to launch a rules-based unit investment trust under a structure called Amplify Convertible Equity Securities that would convert to a traditional ETF based on a predetermined asset level. Whether this structure would only be available to new products or could be integrated to existing funds has not been determined.
“In the current market, brand and distribution really matter,” said Jan van Eck, CEO of VanEck Associates Corp., New York, which manages $33 billion in ETF assets across 58 products. “While you can't leave out performance, flows in this more competitive environment are going to come to asset managers who keep investing in their process and focus on research and development.”