As their popularity among investors continues to grow rapidly, U.S-listed exchange traded funds (ETFs) reached a record $4.15 trillion in aggregate assets under management (AUM) at the end of October 2019, per a detailed report in ETF.com summarized below. “I think the core ETF value proposition, which is extremely low-cost beta that’s transparent, tax efficient and easy to trade, isn’t going to go away,” as Dave Nadig, managing director of ETF.com, remarked in an interview with Investopedia.

Nadig and ETF.com have identified these key trends in the ETF market:

  1. Choices for investors are increasing rapidly.
  2. Assets in ETFs may surpass mutual funds in 5 years.
  3. Rising competition offers challenges for new ETFs.
  4. Actively-managed ETFs should become more common.
  5. Technological advances will reshape the asset management industry.

More Choices for Investors

As of the end of October, there were 2,307 U.S.-listed ETFs, the result of 235 new fund launches and 145 fund closures for the year-to-date. With 62% more openings than closures, the trend is still heavily in the direction of increased choice.

ETFs are primarily associated with equity investments, with 1,392 funds, or 60% out of 2,307, focused on stocks. In second place are fixed income ETFs, with 364 funds, or 16% of the total. In third place with 11% is a combination of geared ETFs, which use leverage to magnify the movement of an underlying index, and synthetic ETFs, which use derivatives and swaps rather than holding the underlying securities, to replicate an index. The remaining 13% of ETFs are largely in commodities.

Fixed income and alternative investments are likely to be the leading areas of growth in the years ahead. Equity ETFs that focus on a specific stock market sector now number 505, or 22% of the 2,307 total. However, in terms of AUM, they account for only 11% of the total, $461 billion out of $4.15 trillion.

Faster Growth Than Mutual Funds

Within the next five years, Nadig anticipates that, in the U.S. market, ETFs may surpass mutual funds in AUM. In particular, the new "ETF Rule," technically SEC Rule 6c-11, may help accelerate the launch of new ETFs yet more. “It is arguably the most important piece of regulatory action to hit the ETF industry since 1993,” Nadig told Barron's.

The new rule both speeds up the process for approving new ETFs and allows for the generalized use of custom creation and redemption baskets that promise to cut costs and improve investment returns. However, Nadig added in his interview with Investopedia, “I think in the next 20 years, we’re going to see a decline in the expansion of ETFs.”

Intense Competition

Regulatory changes are lowering the barriers to entry. However, as the number of ETFs rise, the competitive challenges also are growing, and an increasing number of new funds are finding it difficult to reach profitable scale before they are forced to shut their doors, The Wall Street Journal reports.

In particular, the three biggest players in the ETF market, The Vanguard Group, BlackRock Inc. (BLK), and State Street Corp. (STT), hold commanding market share figures and the attendant name recognition that make it difficult for new entrants to gain a foothold. Collectively, these three firms sponsor 24% of U.S.-listed ETFs, and control 81% of AUM in this market. Add in Invesco Ltd. (IVZ), which has been growing through acquisitions, and the top four players now account for 35% of the ETFs on offer and 86% of AUM.

Regarding the biggest players, Nadig said, “Eventually they’ll have to compete, but they have such an edge in the low-cost beta space that I think you’ll see them focus there for the foreseeable future.” Meanwhile, smaller players and new entrants will have to find other niches where they can innovate.

More Actively-Managed ETFs

The vast majority of ETFs follow low-cost passive investing strategies that track market indices. Funds that utilize active management account for a mere 2.23% of AUM, but 5.76% of revenues.

A barrier to the growth of actively-managed ETFs has been a regulatory requirement that all ETFs disclose their portfolio holdings on a daily basis, putting their proprietary investment strategies and trading activity on full display for anyone to copy. However, the SEC recently approved the Precidian ActiveShares ETF model, which, like mutual funds, makes portfolio disclosures quarterly. As a result, the numbers of actively-managed ETFs are likely to expand especially rapidly.

Impact of Technology

Nadig believes that technological advances will increase competition among asset management firms in general, not just ETFs, and change investor behavior. “I think that these alternative platforms, whether you call them direct indexing or not, are the future of consolidated investment management,” he told Investopedia.