The market for ETFs has seen explosive growth in the past decade, with assets under management (AUM) rising more than 5-fold to an estimated $4.3 trillion this year and projected to reach $5.3 trillion by the end of 2020. But the industry's growth in the next decade may far eclipse the previous one. Assets under management could rise by nearly 12-fold to $50 trillion by 2030, according to a recent note from Bank of America.  

The bold forecast by BofA, implying annual growth of about 25% from 2019 to 2030, better than nearly 19% annually from 2009 to 2019, defies skeptics who believe that an industry shakeout, government regulations, and new rivals could impair the growth of ETFs. Moreover, $50 trillion in AUM would be more than double the current size of the U.S. economy, given that annualized U.S. GDP was $21.5 trillion in Q3 2019.

Key Takeaways

  • Bank of America projects even more rapid growth for ETFs ahead.
  • Skeptics see this projection as overly optimistic.
  • ETFs face increasing regulatory scrutiny and competitive challenges.
  • How ETF holders behave in the next market decline is a big unknown.

Significance For Investors

As more evidence of how aggressive the prediction from BofA is, Jim Ross, one of the founders of the ETF industry, predicted in 2018 that worldwide ETF AUM could reach $25 trillion by the end of 2025. Ross, a longtime executive at leading ETF sponsor State Street Corp. (STT), was a key figure in the design and 1993 launch of the first U.S.-listed ETF, the SPDR S&P 500 ETF (SPY). On the other hand, BofA's projection covers 5 additional years.

The growth of ETFs, BofA observes, is being driven by “increased awareness” among investors of key advantages offered by these investment vehicles, such as tax efficiency, low cost, liquidity, and transparency. Stable interest rates, expectations of positive returns on stocks, and narrow credit spreads also could help to spur additional ETF growth in 2020, per BofA.

Moreover, the vast majority of ETFs are passive investment vehicles that track market indices. As more costly actively managed funds increasingly underperform the indices, investors are abandoning them for cheaper passive alternatives, mainly ETFs, that also have been delivering better returns on average.

As noted above, BofA's forecast of annual growth averaging 25% over the next decade is very aggressive in itself, never mind that it is above the 19% rate recorded over the prior decade. "The numbers for launches and closures suggest a stable and mature industry that has already seen its most dramatic growth," is the conclusion of a report by Indeed, the industry appears to be in period of shakeout. Smaller players that lack economies of scale are closing at a rising rate, and it's becoming increasingly difficult for any new fund to reach profitable scale.

The U.S. ETF market also is highly concentrated, with the top 3 players controlling nearly $3.5 trillion in AUM, or more than 80% of the total. These are BlackRock Inc. (BLK), The Vanguard Group, and State Street Corp.

The dominant combined position of these 3 issuers, and the potential for them to stifle competition, has the attention of regulators, especially those in the Securities and Exchange Commission (SEC). “I am concerned about what it will mean for investors--particularly Main Street investors--if the variety and choice offered by small and midsize asset managers become lost in a wave of consolidation and fee compression,” Dalia Blass, director of the SEC’s investment management division, remarked at an Investment Company Institute (ICI) conference in March.

Looking Ahead

Another headwind for ETFs may be private capital funds, including private equity, venture capital, infrastructure, real estate, and private debt funds. These vehicles have been attracting new money from investors at about double the rate of ETFs. Whether this poses a long-term risk to future ETF growth is unclear.

Finally, there is widespread concern that a wave of selling by panicked holders of passive ETFs could turn a modest market selloff into a full-fledged crash. Seeing "an increased tail risk of a sell-off in the market becoming disorderly," Inigo Fraser-Jenkins, head of global quantitative and European equity strategy at Sanford C. Bernstein & Co., has warned, "we basically do not know what will happen when thousands of investors reach for their smart phones and try to sell positions that they have in passive ETF products."