Flooded market invites further consolidation for issuers

It has been a few years since merger activity has impacted the exchange-traded fund market. But further consolidation could be around the corner as issuers in the middle of the market seek out ways to scale up in an increasingly competitive landscape.

Since the U.S. Securities and Exchange Commission implemented 6c-11, better known as the ETF Rule, in late 2019, the number of ETF issuers jumped to 226 from 122, according to data provided by FactSet Research Systems. Without the complex process of gaining "exemptive relief" from certain sections of the Investment Company Act of 1940, new entrants were able to quickly launch passive and active ETFs, provided that the fund portfolios were disclosed daily.

But that rush of activity barely put a dent into what has long been a top-heavy market. At the close of 2019, BlackRock, Vanguard Group and State Street Global Advisors controlled 81% of U.S. ETF assets under management. While their collective dominance has diminished slightly to 75.5%, the assets controlled by the 20 largest issuers has held steady: 96.7% compared with 98.2% at the end of 2019.

"6c-11 made it easier than ever to launch ETFs, but harder and harder to distribute," said Jillian Delsignore, a veteran ETF distribution executive with experience at BlackRock, J.P. Morgan Asset Management, and, most recently FLX Networks.

The flood of new products — from trend-chasing thematics, to greater depth in fixed-income markets, to funds using derivatives to cap downside risk — had brokerage platforms "putting up higher gates" to get an ETF approved for wealth management clients, according to Delsignore. And institutional investors, unless involved in sponsoring or seeding the fund, rarely show up in new ETFs.

According to FactSet, 69% of ETF issuers offer five products or less, and 71% manage less than $1 billion in their ETF suite.

"There's always been an entrepreneurial spirit in this business. Everyone wants to pitch the next billion-dollar fund, but very few get there," said Christian Magoon, founder and CEO of Amplify ETFs. "It's getting even tougher to compete."

Amplify announced plans in June to take over management of funds issued by ETF Managers Group. Once approved by shareholders of the individual ETFMG funds, Amplify will manage over $8 billion in assets, potentially pushing it into the top 30 of ETF issuers, yet still with just 0.1% of the total market.

Magoon, who has been through several cycles of manager M&A, said that "calls are getting returned" on deal inquiries as ETF issuers face the economic realities of negative flows and higher operating costs. The pursuit of the ETFMG products was also precipitated by a 20% minority investment in Amplify by Samsung Asset Management in April 2022.

A handful of other transactions over the summer show that Amplify is not alone in driving consolidation in the middle market.

In July, TCW Group announced plans to take over the ETF business of investment firm Engine No. 1. The firm's flagship product is the $537 million Transform 500 ETF, which tracks a cap-weighted Morningstar index of the 500 largest U.S.-listed companies. With an expense ratio of 0.05%, similar to S&P 500 index funds, the ETF was marketed to investors looking for an index manager willing to engage in the type of aggressive shareholder activism that brought Engine No. 1 a proxy victory against Exxon Mobil in 2021.

And, in late August, Clough Capital Partners assumed management of Changebridge Capital's active ETFs, bringing back former executive Vince Lorusso as the firm's new president and CEO. Lorusso had left Clough Capital in July 2020 to launch Changebridge.

"The asset management industry is being challenged by meager organic growth and burgeoning costs," said Yuri Feldman, partner at NMG Consulting in New York.

Feldman believes that "growth-challenged" managers will be looking for ways to add greater exposure to passive products. "At the same time, many smaller ETF providers have recognized that it can be an uphill battle to deliver profitable growth in a highly competitive distribution landscape."

While a manager's complementary products or distribution opportunities can make a deal appealing, acquirers are also looking for targets that might have "assets in duplicative strategies which can be run by a single investment team rather than two," said Jonathan Stern, a partner and leader of the investment management advisory practice at Berkshire Global Advisors in New York.

NMG Group's Feldman adds that "relying on just one or two large products" is risky for any business, but particularly challenging for boutique index providers, given the relative ease of shifting indexes as opposed to advisory contracts.

Since April, ETF-focused research, news and data firm VettaFi has added two index publishers to its suite of businesses, ROBO Global and EQM Indexes, to complement its consolidation of energy and master limited partnership index brand Alerian and cap-weighted custom indexer S-Network Global Indexes.

"Combining resources to get to scale is a good and healthy thing," said Jane Edmondson, who joined VettaFi from EQM as head of thematic strategies and custom indexes.

Of course, another way to "scale" is also on the rise in 2023. U.S. issuers had closed 173 ETFs through the first week of September, according to ETF.com, compared with 146 for all of 2022.