Fund closures have risen and new launches have slowed, suggesting supply is meeting the high demand
Last year was a phenomenal one for ETFs. Global ETF assets hit a new high of $4.7trn at the end of December, up from $3.5trn a year earlier. Its 35 per cent annual increase in assets was the biggest the ETF industry has seen since 2009, boosted by record inflows of $665bn.
It is fair to say ETFs are one of the investment world’s biggest success stories of the past decade. That said, looking more closely, some numbers suggest the story is more nuanced than one would believe.
The US continues to take the lion’s share of the global market, commanding 73 per cent of assets (see figure 1). This market share has barely changed over the past three years. Tax efficiency for ETFs in the US is an added advantage compared to Europe and the distribution channels are much more open.
But the Old Continent is catching up. In fact, last year, for the first time, ETF assets in Europe expanded at a faster rate than the US (42 per cent versus 35 per cent). Growth is expected to accelerate further, spurred by a combination of regulatory changes and continued innovation.
Mifid II will provide more transparency around trading and liquidity and, because ETFs do not pay commissions, they will benefit from a more level playing field.
Meanwhile, the global ETF industry remains highly concentrated, with three firms controlling 70 per cent of all assets. BlackRock, the world’s largest fund manager, is by far the leading provider, followed by Vanguard and State Street (see figure 2).
iShares’ predominance is all the more striking in Europe, where the firm monopolises almost 45 per cent of assets. Xtrackers and Lyxor come in second and third position, with only 20 per cent combined.
While such a top-heavy league table would raise competition concerns in other industries, it is not considered an issue here. Price competition in the ETF market is fierce, and fees keep falling all over world.
That said, many ETFs are struggling to gather assets. Nearly two-thirds globally hold less than $100m; the minimum size often required for an ETF to be profitable. This means a large number on offer today will likely cease to exist in five years’ time. Indexing is a low-margin business where scale is critical to cover the costs.
Interestingly, this does not seem to deter new entrants. Close to 50 companies globally issued their first ETFs last year, and many more are expected to join the fray. New players, including traditional active managers such as JP Morgan, Fidelity and Franklin Templeton are looking to grab a share of the growing pie.
Last year saw the launch of 155 ETFs in Europe, a whopping 41 per cent of which had a smart beta flavour. Smart beta, which aims to deliver superior risk-adjusted returns than conventional market indices, has been a key area of product development in recent years as demand for factor-based strategies and targeted solutions rises.
However, it would be a mistake to think that product development in Europe, as measured by the number of new ETF launches, is heating up. As figure 3 shows, it has actually slowed down.
At the same time, the number of fund closures is rising (see figure 4). Some may instinctively take this as a bad sign, but it can in fact be viewed as a healthy attribute of market maturation.
It appears providers are becoming more willing to shut the doors on funds that fail to capture assets.
Hortense Bioy is director or passive fund research at Morningstar, Europe