$4 Trillion ETF Industry Faces Shakeout in 'Oversaturated Market'

The $4 trillion ETF industry has enjoyed rapid growth over the past quarter century, but now is entering a period of shakeout in which smaller players that lack economies of scale are closing. Through early October, at least 90 funds have closed so far in 2019, after a record 139 closures in 2018. Meanwhile, launches of new exchange-traded products, including ETFs and ETNs, peaked in 2011, according to FactSet Research Systems data cited in a detailed report by The Wall Street Journal.

“The challenge is as the industry has more and more participants it becomes harder to expand out into the marketplace,” as Michael Sapir, CEO of ETF issuer ProShares, told the Journal. “There’s a lot of roadkill out there," he added. "The numbers for launches and closures suggest a stable and mature industry that has already seen its most dramatic growth but still has plenty of runway ahead of it," is the conclusion of a report in ETF.com.

Key Takeaways

  • ETF closures are rising, as many funds fail to reach profitable scale.
  • The biggest ETF issuers are increasing their market share.
  • The popularity of low-cost passive investing helps the biggest issuers.

Significance for Investors

The annual pace of new ETF launches peaked at over 300 in 2011, averaged less than 200 from 2012 to 2014, then rebounded to average more than 250 from 2015 to 2018. So far in 2019, the number is approaching 200. Meanwhile, closures have been increasing since 2011.

The biggest competitors are becoming even more dominant. Total ETF assets grew by 90% in the five years through Aug. 2019, but 83% of that growth was captured by just 100 funds out of 2,100 (or 4.8%), per CFRA Research. Additionally, more than two-thirds of those 100 funds are managed by ETF giants BlackRock Inc. (BLK) and The Vanguard Group.

The three biggest ETF brands are, with their assets under management (AUM): iShares from BlackRock, $1.604 trillion, Vanguard, $1.064 trillion, and SPDRs from State Street Corp. (STT), $665 million, for a collective $3.333 trillion. This data is from FactSet as of Oct. 22, as reported by ETF.com.

An ETF typically must reach AUM of between $50 million and $100 million within its first three to five years to become profitable, says Elisabeth Kashner, the director of ETF research at FactSet, as reported by the Journal. Moreover, new ETFs that fail to reach $50 million within their first year probably will fail.

Among funds launched from 2007 to 2016 with AUM under $50 million after one year, 44% closed and another 30% never surpassed that amount. Among funds launched in 2018, more than 80% ended the year with less than $50 million.

The market for U.S.-based mutual funds is much larger than that for ETFs, with about 8,000 funds and AUM of $15.4 trillion, but about 25% of those assets are passively-managed funds, per Morningstar. They also find that ETFs are gaining market share, adding about $135 billion in assets so far this year, while mutual funds have lost about $200 billion.

Looking Ahead

Since more than half of the approximately 2,100 exchange-traded products listed in the U.S. have AUM of less than $100 million, the pace of fund closures and industry consolidation is likely to accelerate, observes David Perlman, an ETF strategist at UBS, per the Journal. Also, as investors increasingly favor passively-managed ETFs over actively-managed funds partly, if not primarily, based on low cost, the biggest players with the largest economies of scale should become even more dominant.