The future of ETF market

The ETF market can expect further growth in the next few years, whether in terms of inflows and assets under management or in terms of new products coming out.

James Ross, chairman of State Street Global Advisors, said in March that ETFs could reach $25 trillion in assets under management by 2025. Remember, the market was still under $5 trillion at the beginning of 2018.

“Though this estimate is considerably higher than the industry consensus, we believe that many experts are vastly underestimating the potential for future growth in the ETF market,” he wrote in a blog post.

“ETF assets have roughly doubled every three years since 2000 and posted record-breaking inflows in 2017.”

He cites four main drivers for that growth: the expansion of retirement accounts, the adoption by millennials, a still untapped global market, particularly in Asia, and nearly $6 trillion in insurance
company general accounts that for the most part hasn’t been able to move into ETFs.

Where will that growth come from?

According to experts, it will be mainly driven by non-US products and by non-stock products.

In 2017, there has already been a significant pick up in ETFs focused on overseas markets, including Europe, China and other developed and developing markets. This trend will only continue. There could also be new products focused on Latin America coming out in the next few years.

Innovation will likely come more from the fixed- income side where strategies are less developed than in equities at this point.

“One thing you’ll continue to see in the not-so- distant future is the adoption of smart-beta ETFs but in the fixed income universe,” says Joe Tenaglia, asset allocation strategist at Wisdom Tree.

Smart-beta funds are popular with stocks. But some people might not think that market-cap weighting makes sense in the fixed income market.

“What that means is that the more leverage the issuer takes on, the greater weight it will receive in an index. When you are cap-weighing in fixed income ETFs, you’re giving the largest weight to the most levered issuer. It makes no sense at all. But so far, very few ETF investors have come around to this thinking and very few have started to allocate to non-cap- weighted fixed income smart-beta ETFs.”

Tenaglia thinks that for that reason, there’s a lot more room to grow in fixed income because the asset pool in the smart-beta ETFs is still very small and has much further room to evolve.

“That’s a trend you’re going to continue see pick up over the next few years and that’s one we’ve looked into as well in developing our own strategy,” he adds.

One of the big questions as the ETF industry has skyrocketed pertains to how ETFs will behave in the next downturn. The stock market has been on a bull run for about nine years, which is on the longer side compared to prior economic cycles, and market participants anticipate that in the next couple of years, investors’ sentiment about the economy, the stock market and even in general, will shift.

Will ETFs exacerbate a sell-off as some fear? Are ETF managers and issuers soundproofing offerings so their funds will avoid being decimated?

At less than $1 trillion in assets under management, the ETF industry was much smaller a decade ago
when the global financial crisis began than it is nowadays, making it difficult to learn from the past.

The few ETFs that were around stood the sell-off quite well despite high-trade volume—it’s important to note that these funds around back then are still some of the largest and most traded ones today.

The correction of February can also offer clues, showing that again, trading volume increased but there wasn’t a severe impact from a liquidity perspective.

Still, some firms have been actively preparing for a potential downturn.

One important step State Street Global Advisors has embraced is extra communication with investors to share insights on markets in real time.

Wisdom Tree, for its part, took some concrete steps to enhance diversification and its tracking methodologies. For example, it has created caps on certain sectors to make sure they are not overrepresented in each fund.

“We had a US small cap dividend fund that was more than 50% in financials at the height of the financial crisis,” says Tenaglia. “Some of the things that we’ve done since then is that we’ve
learned from our experience in that we decided to implement maximum sector exposure and maximum country exposure that any ETF can have at any given point in time. That 50% plus in financials would never happen again in any of our ETFs based on the experience and what we’ve learned from that.”

The future is bright for the ETF industry and investors can expect innovation with new products, new methodologies and new structures in addition to an expected global expansion.

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