Reports of the decline of ETFs have been greatly exaggerated
Deborah Fuhr
Exchange-traded funds reached several milestones recently. At the end of last month, they turned 20 and their global assets, along with exchange-traded products, breached the $2 trillion mark with a collective $2.05 trillion.
Many people now consider ETFs to be a mature financial instrument, suggesting future declines in product design and innovation, number and type of users, uses, trading volumes and product launches, exchanges listing them, indices, markets and asset classes covered and brokers trading them.
Our view is somewhat contrarian. We see ETFs today thriving in the introductory phase of a product’s lifecycle and expect them to continue their relative and absolute high growth rates. Over the past 10 years, the compound annual growth rate in assets has been 29.6% and we see no reason for significant decreases. ETFs will continue to grow in number, assets under management and users.
Growth depends in part on the characteristics that made ETFs popular in the first place. They have fundamentally changed the way investors access a variety of markets and asset classes. They are unique because they are democratic, offering the same tool box of exposures to all types of investors at the same annual cost for a minimum investment of typically less than $1,000. This explains why ETFs may be considered one of the most useful financial innovations in the past 25 years.
When State Street Global Advisors launched the SPDR two decades ago, who would have thought this ETF would spawn an industry? Just consider: it took ETFs in the US 18 years to accumulate $1 trillion – mutual funds took 66 years.
The ETF success story has been one of growth, beginning as a niche instrument developed to access world equity benchmarks and continuing to become a product powerhouse used by financial advisers, institutional and retail investors and covering an expanding range of asset classes from equity and fixed income to commodities and alternative exposures. As of January this year, there were 4,770 ETFs and ETPs with 9,817 listings from 209 providers on 56 exchanges.
Worldwide, the number of institutional investors using ETFs has grown at a compound annual rate of 8.7% over the five years to the end of 2011, according to analysis of Thomson Reuters data, and we expect this to trend continue.
Although institutional investors were early proponents of ETFs, they are no longer alone. Today’s ETF investor is diverse, running the gamut from Wall Street to Main Street. ETFs find their way into portfolios of varying size and complexity because they are simple, transparent, cost-efficient, liquid, diversified and flexible. And, because ETFs are generally passive products, they attract those disillusioned with active managers who consistently fail to deliver alpha. In 2011 Standard and Poor’s found that 81.2% of active large-cap managers in the US did not beat the S&P 500 index.
Tax, regulations, availability and benefits relative to alternative products will continue to drive usage patterns and product development. Many investors use ETFs to gain exposure to markets, such as China and India, and asset classes that can otherwise be difficult to access.
In the US, financial advisers and hence retail investors are big users of ETFs, which is not the case in other parts of the world. Financial advisers are typically paid to sell products, but not ETFs. Regulations like the Retail Distribution Review in the UK and similar changes in Australia and Holland are encouraging advisers to move to fee-based advice. When financial advisers embrace ETFs the message is passed down to their retail clients.
Innovation will continue to be an important driver of growth. The challenge for ETFs continues to be one of education – investors still need help to decide how, when and which ETFs to use.