The exchange traded products industry is into its second decade of exponential growth. On a global basis, there were $2.2 trillion in ETP assets under management at the end of August.
Industry growth is still in the early innings as some observers expect increased adaptation of ETFs, by both professional and retail investors, could help the industry-wide AUM total more than double over the next several years.
“Despite the positive developments and optimistic outlook, there is no denying that a business-as-usual approach is unlikely to lead to success in the future,” according to a report by PwC’s asset-management strategists.
Advisors have embraced ETFs, helping drive the industry’s stellar growth rate in recent years, but the expectation is that larger institutional investors, such as endowment and pension plans, along with hedge funds will drive ETF growth in the future.
“The institutional client base will continue to become more diverse, with investors ranging from insurance companies to hedge funds and retail investors expected to contribute meaningfully to the growth of ETF assets,” said PWC. [Schwab Impact: How Advisors are Adapting to ETF Growth]
PwC highlighted some of the advantages of ETFs that long-time users are already familiar with, including liquidity, transparency, cost efficiencies, tax efficiency and intra-day pricing.
“For many, ETFs represent a better ‘mouse trap’ when compared to traditional mutual funds. This is particularly true for advisors who have been at the forefront of a movement that places less emphasis on security selection while focusing more heavily on asset allocation,” PwC said in the report. [How Advisors can Target Service to ETF Clients]
However, there are still mountains to climb for the ETF business, including the retirement market. In particular, the 401(k) market, which some view as a mega-growth frontier for the ETF industry. The issues is getting there.
ETF sponsors want to access that $2.7 trillion market, but “they have their work cut out for them. More than three out of four ETF firms say 401(k) platform support and product proliferation is a major or moderate challenge. Some managers have little to gain, since their mutual funds already play a large role in that market. Others are moving cautiously, aware that sales are not likely to come as easily in the DC market and leery of investing too heavily in an unproven opportunity,” according to PwC.
Another hurdle ETF sponsors face is, as PwC puts it, “lack of technical understanding.” Specifically, even advisors that see themselves as proficient in ETFs, fail to comprehend the difference between an ETF’s volume and its true, underlying liquidity. That scenario keeps advisors and their clients out of small of ETFs, some of which have surged this year. [10 Small Sector ETFs With Huge Returns]
Regulatory hurdles facing active ETFs are another hurdle to be dealt with.
“Some firms have already jumped through the hoops necessary to launch active ETFs, but the process remains a challenge as active ETFs are not subject to the same generic listing requirements as passively managed ETFs. Thus, the ETF sponsor must obtain approvals for each active ETF portfolio on Form 19b-4, which can take a year or more depending on the novelty of the filing to obtain SEC approval,” said PwC.
Other risks to industry growth highlighted by PwC include operational issues, such as liquidity, counter-party risk, tracking error and trade failures, and regulatory burdens.
Roles of ETFs in Client Portfolios
Chart Courtesy: PwC
ETF Trends editorial team contributed to this post.