ETFs as ‘Disruptive Technology’ | ETF Trends

In the world of capital markets, the exchange traded fund is a textbook case of a “disruptive technology,” says ConvergEx Group chief market strategist Nicholas Colas.

The first ETF in the U.S., SPDR S&P 500 (NYSEArca: SPY), was launched 19 years ago and the business has mushroomed to over $ 1 trillion in total assets.

Citing Clayton Christensen’s book The Investor’s Dilemma, Colas explains that disruptive technology happens when new competitors with a cost advantage, but not much else, target the cheapest offerings in a given industry.

Indeed, ETFs started out as low-cost funds that tracked broad-market indices for stocks and bonds. Essentially, they were index funds that offered better tax efficiency and the ability to trade during the day.

“The established players … aren’t especially concerned with holding market share at the low end – they have more profitable fish to fry. So they let the new players take over the cheap stuff,” Colas wrote in a note Wednesday.

“Over time, the new entrants begin to expand their product offering up the price scale. Again, the existing players cede the battlefield. Their margins, after all, are still rising as they exit lower profit segments,” he added. “Before the entrenched players fully realize it, they have lost their entire market. What’s even worse than that, however, it that they intentionally did so. And for ostensibly ‘good’ reasons. After all, they held onto the high margin high-end as long as they could.”

Although most of the assets in the ETF business are held in passively managed index portfolios, active ETFs are a big potential growth area.