Assets invested in exchange-traded funds (ETFs) worldwide may rise by about two thirds to 7.6 trillion dollars through 2020, as more investors favor their low cost and liquidity, according to a new report1 by EY that includes a survey of industry participants.
The consultancy firm estimated in its annual study of ETFs that the funds’ assets stood at 4.4 trillion dollars in September 2017, having grown at a cumulative average annual rate of 21% since 2005.
While broadening ETF adoption has been a boon to sponsors, the next years will also present challenges such as stiff competition, EY said.
“As the industry grows in size and influence, it faces far more complex challenges,” the report’s authors wrote. “It is no longer sufficient for an ETF to be cheaper, more liquid or more alternative than a competing mutual fund.”
Innovating around investors
Overall, the ETF market’s trajectory will be defined by sponsors’ reaction to four main trends, according to EY.
In the first place, traditional asset managers will join the ETF market, EY forecasts, adding pressure to offer products that satisfy unique needs or provide an edge.
Products that will win out are those that target the right audience at the right time, EY said. The authors had four pieces of advice: the fund providers must anticipate investor needs, keep the ‘big picture’ in mind, look beyond the short term, and provide investor education.
Experience and costs
The second issue will evolve around refining offerings. Sponsors will need to customize experiences along enhanced segmentation to address long-term needs of different investor groups, said EY.
The drive to lower costs will represent a third pillar of the ETF’s market evolution. Fund costs globally have fallen from 33 basis points (bps) in 2014 to 27bps in 2017, according to EY. More than 70% of respondents in the survey expect margins to fall further over the next three years, as inflows head to the cheapest products and differentiation intensifies among issuers.
The role of regulation
Regulation may actually help ETFs. A vast majority of respondents in the survey believe investors welcome new rules, which are focusing globally on transparency, on-exchange trading, best execution, and on restricting mutual fund managers’ inducements.
However, not all effects of increased regulation will be positive, the report says. In particular, rules aimed at limiting systemic risk may curb trading turnover, and the growing complexity of ETFs may make rules harder to navigate.
Emerging trends in innovation
EY expects a continued shift of money flows towards passive investments, and predicts that assets in passive funds could exceed those in active funds by 2027.
Fixed-income ETFs will be the industry’s greatest focus in the next few years, according to the report. EY expects investments in bond ETFs to reach 1.6 trillion dollars by 2020, from 600 billion in 2016, despite concerns about limited supply in the underlying market.
Thematic, smart beta and ESG products will drive growth in equity ETFs, as will the continued search for liquidity in traditional strategies, EY said. Smart-beta assets will reach 1.2 trillion dollars by 2020, from 600 billion in 2016, helped by factor-based strategies, the report estimated.
The survey also covered the role of asset servicers and of financial technology in fostering successful ETF products. It also reviewed the potential for industry acquisitions and partnerships.
The survey consulted 70 leading ETF market participants who help manage 85% of global ETF assets.
1 EY, ‘Reshaping around the investor,’ Global ETF Research 2017.