Majority of asset managers expected to offer ETFs in next five years

Tuesday, 28 November 2017

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  • Exchange-traded fund (ETF) market on track to reach US$7.6t by end of 2020
  • 15% to 25% of ETF inflows over the next three years expected to come from new investors
  • Innovation to meet investor preferences crucial to sustainable industry growth

Two-thirds (67%) of respondents interviewed for the EY report Global ETF Research 2017: reshaping around the investor believe most managers will have an ETF offering in the next five years. The new entrants will join a market that is expected to reach US$7.6t globally by the end of 2020.

Based on interviews with ETF market makers, service providers and promoters who collectively manage 85% of global ETF assets, the report suggests that ETF providers will face new challenges as the industry grows in size and influence.

EY Oceania Wealth and Asset Management Leader, Antoinette Elias says, “ETFs can no longer just be cheaper or more liquid than actively managed mutual funds. The industry will need to innovate around investors, refine investor journeys and reduce investor costs to remain competitive.”

“In Australia, we continue to experience significant growth, with the ETF market capitalization increasing by 39% in the last 12 months – to AU$33.3bn as at 31 October 2017. The local ETF market is taking a growing share of the traditional managed funds space and continues to be retail investor driven, rather than institutional. Access to broader asset classes and international exposure is making ETFs increasingly attractive to retail investors,” Ms Elias says.

How investors use ETFs

The ETF market will be transformed by both current and new investors. The research suggests that 15% to 25% of ETF inflows over the next three years will come from new investors – an inflow of US$250b. Investors typically first turn to ETFs for selected exposures they cannot access elsewhere, but then become more comfortable using them as the building blocks of portfolio construction.

Globally, institutional investors will continue to dominate ETF investing over the next three years, according to 97% of interviewees. The report highlights wealth managers, private banks and investment funds as promising areas for growth. It also states that pension funds are expected to use ETFs for liquidity management while wealth managers are expected to look for core exposure through model portfolios. Certain hedge funds will use leveraged and inverse ETFs to execute high-conviction long or short positions.

EY Oceania ETF Leader, Rita Da Silva says, "The ETF industry needs to do more to help define the proposition for institutions and refine the investor journey for retail investors by understanding and anticipating the long-term needs of different investment groups, addressing their concerns and developing the expertise needed to meet their unique challenges.”

“Australian investors are increasingly turning to ETFs for simplicity, transparency, low cost and diversification, and due to easy access. However, education is key to ensure that investment decisions are well informed and based on an underlying understanding of ETFs, and not blindly led. ETFs growth may in part be due to perceived dissatisfaction with the performance and high fees of traditional active managers, but investment advisors on the whole would argue that passive investment should only form part of a diversified investment strategy. To take advantage of the attractiveness of ETFs, active managers have launched active exchange traded managed funds in the last two years and this trend, together with increasing numbers of smart-beta ETFs, is expected to continue.”

Innovating in a complex market

The research shows that 2.9% of inflows now go to funds with assets under management (AUM) below US$100m. Fifty-five percent of respondents said they did not believe the success ratio of new launches will improve in the future. According to the report, ETF providers will need to anticipate investor needs, incorporate macro trends in regulation and technology, and focus on educating investors. Product development will take many forms, including new thematic ETFs, greater access to debt and investing in alternatives.

ETF offerings will help new entrants defend against declining mutual fund inflows. For many of them, ETFs will only form a part of their product range and will focus on emerging areas such as fixed income or smart beta.

Falling fees and new competition

ETF fees continue to fall, reaching on average 27 basis points last year according to the research. While the report contends that “zero-fee” ETFs will not become the norm, 71% of people interviewed expect fees to fall further as becoming a low-cost provider becomes a prerequisite to survival. Assets in passive funds will exceed assets in active funds globally in 10 years and ETFs will benefit disproportionately from this shift because of their low fees and intraday liquidity in volatile markets.

Beyond top-line fees, firms are future-proofing operating models by looking to reduce all costs of ownership. Forty-three percent of respondents feel there is insufficient competition between index providers and expect more players to enter the space, including more self-indexing. Participating in stock lending programs, digital distribution and best execution are other ways to continue to bring down costs for investors.

Guiding investors through regulation

Sixty-one percent of people interviewed for the report expect regulation to change the way ETFs are distributed. ETFs globally should, in aggregate, benefit from regulatory changes, such as the Department of Labor Fiduciary Rule and MiFID II, as these changes should lead to greater transparency. But as the regulatory landscape continues to grow, there is additional scrutiny of the industry’s systemic risk, including liquidity, and taxation.

“The ETF industry needs to address market and regulatory threats and be willing to respond by developing new products and modifying existing ones. A combination of local understanding and global insights can help investors understand the overall business environment and how this will impact investor journeys,” Ms Da Silva says.

The complete research is available at ey.com/etf2017.

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Notes to Editors

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About the report

The report draws on interviews with 70 leading ETF promoters, market makers and service providers and is supplemented by EY’s own analysis and knowledge. Respondents, who manage 85% of global ETF assets, were interviewed across the US, Europe and Asia between May and September 2017.