There have been several reports written recently that try to predict the future growth rate of the ETF industry and its march against mutual funds. They are filled with plenty of statistical analysis and one main assumption about whether or not ETFs will be included into the 401k platforms. These reports are flawed and do not accurately depict what is happening in the world of ETFs. What is missing are the intangible characteristics of the ETF industry that do not show up in any data base. As Mark Twain once said, “there are lies, damn lies and statistics.”
Let’s look at some of the key non statistical reasons why growth in the ETF industry will remain strong with or without the 401k platforms; the ETF structure itself which induces innovation and adapts to various market conditions, new distribution channels being created and existing mutual fund complexes entering the space.
The ETF structure has allowed investors to access hard to reach asset classes and invest in those assets in the same manner in which they execute a stock trade. Commodities, fixed income, currencies and volatility all are now investable asset classes for the masses through the ETF structure. The benefits that are inherent in the ETF structure (low costs, transparency, tax advantages, and access) are deployed directly to the end user. Who benefits from ETFs? Investors. Who benefited from CMOs and CDOs? Banks and bankers.
The structure perpetuates growth by being a platform for innovative products. The statistical information we are looking at in terms of ETF products coming to market is based on the current environment of low interest rates, low inflation and anemic growth. So, when this environment changes, the opportunistic nature of innovation inbred in the ETF structure will create another wave of new products that will adapt to a changing investment climate. Now repeat this process over the next decade or more and you have another leg of growth that is not seen in the current data.
Let's not underestimate the potential of new and growing distribution channels. ETF sponsors no longer prioritize product development as a key competitive differentiator but instead are focused on distribution and creating new distribution channels. It is similar to what happen in the computer chip industry, once the chip was made as small and as fast as possible the industry began to uncover new applications for those chips. The same is happening in the ETF industry; new ways to use ETFs and new users will also help increase growth rates from the current trends. Case in point is the growing interest in ETF managed portfolio platforms and the opportunities they present.
The buzz in the ETF world the last few years was all the new SEC filings from some of the largest asset managers looking to create actively-managed ETF businesses- very few actually have. The belief is that they are using those filings as a place holder as they watch this new market for active ETFs develop. Is it a potential strategic miscalculation? I believe so, because the industry is not active vs. passive but rather active and passive. The example here is Blackrock and Invesco, both made significant investments in a passive solution for their clients ( iShares and PowerShares respectfully) and both acquisitions have proven to be accretive to earnings. At some point the other large fund complexes will be under pressure from their shareholders and will enter the passive ETF business with their massive distribution capabilities. Imagine how quickly the 401k platforms will open up to ETFs once the likes of Fidelity, Eaton Vance, T-Rowe Price and Legg Mason jump into the ETF arena.
Suggesting that ETF growth is slowing down because of the current trend in product launches and the road blocks on the 401k platforms creates an incomplete view of the true benefits of ETFs. There is no statistical data that provides a view into the heart and soul of the ETF industry-innovation. Investors will always seek new ways to access the market and protect their assets. ETFs will be the delivery vehicle of choice for innovative products. Add in ever changing market conditions, new distribution channels and new entrants and we can begin to see why ETF assets will sustain or exceed their current growth rates for a very long time.