Twenty-three years after it was introduced by State Street, the ETF is poised to become the financial product of choice for investors and advisors, according to recent analysis by Tiburon Strategic Advisors, a Tiburon, Calif.-based research and consulting firm.
There are 1,700 U.S. ETFs with $2.2 trillion in assets among them. In 1997, shortly after they were first introduced on the American Stock Exchange, there were 19, said Charles "Chip" Roame, Tiburon managing partner, in a Thursday web conference.
“ETFs have become the passive product of choice,” Roame said. “We look at them and say they’re booming because they have nine or 10 advantages, and products with that many advantages are going to continue to grow for a long time.”
Roame projects that ETF assets will swell to $10 trillion to $12 trillion, driven by the growth of their use as passive, core products, their popularity in managed accounts, their eventual implementation in defined contribution plans and their widespread global popularity.
The ETF market is dominated by passive products, with 90 percent of all assets in passive funds, he said.
“The core ETF product will continue to boom,” Roame said. “I’ve listened to arguments about why the growth of passive, index-based investing will slow, and I still think that the ETF as a product will continue to grow.”
The ETF’s versatility appeals to passive, buy-and-hold, fundamental investors and active, market-timing, tactical investors, said Roame.
Buy-and-hold investors appreciate the ETF’s lower expense ratios, transparency, tax efficiency and the lack of a tax drag, while market timers appreciate that ETFs are liquid, continually priced, easily redeemed, eligible for margin purchases and the short-sell rule, and can be traded with stop-loss, market and limit orders.
Active ETFs, on the other hand, already a small part of the market, are more likely to stagnate or grow moderately, said Roame.
“We’re skeptical about active ETFs,” Roame said. “They’re being introduced in a couple of interesting models, but they’re still nowhere near the trend of passive ETFs.”
Perhaps that’s because, until the recent introduction of Eaton Vance’s NextShares exchange-traded managed funds, active ETFs mainly consisted of commodities and fixed-income products.
“The active ETF market is very much a niche market,” Roame said, noting that a larger trend away from active products and towards indexing might also be responsible. “Mutual funds as a whole have positive flows, too, but active mutual funds have had negative flows.”
On the other hand, the use of ETFs within managed accounts is likely to grow, said Roame, specifically referring to fee-based accounts that invest clients in portfolios of ETFs.
ETF providers have three target markets for managed accounts, said Roame: do-it-yourself RIAs, turnkey asset manager programs and companies with large forces of advisors.
While Tiburon has positive views about the use of ETFs in managed accounts, the real catalyst for growth could be their eventual inclusion in 401(k) plans.
“We’re positive that someone will figure out the 401k answer for ETFs,” Roame said. “I think some people underestimate the importance of this, but if you strip away 401(k) flows from the mutual fund arena, you’ll find that mutual funds are a struggling product today.”
Roame said that mutual fund assets mushroomed after they were embraced by defined contribution plans in the 1980s and 1990s, and the same could happen to ETFs when they’re implemented in the $5.5 trillion 401(k) market.
The ETF market will also continue to globalize. According to Tiburon, the total global ETF market is around $3.1 trillion, $2.2 trillion of which is located in the U.S.
“ETFs are booming around the world,” Roame said. “They’re taking off everywhere. in just about every country. The U.K., Canada, Israel, India, and now virtually everyone have ETFs.”
The leading ETF sponsors are BlackRock, State Street and Vanguard, but Tiburon expects market share to level off in the future.
“Over the past two years, $470 billion has gone to some money managers simply because consumers and advisors are picking the passive ETF market as the place to send their flows,” Roame said. ”The big benefactors have been Vanguard, State Street and BlackRock, but some other companies are starting to do well as well, like WisdomTree and PowerShares. There’s lots of money sloshing around for people to pick up.”
While the “big three” might lose market share, Roame said they would likely still grow in assets as flows into ETFs continue to accelerate.
Shifting distribution channels will also drive ETF growth, Roame said. In 2015, fee-based advisors were responsible for $475 billion of the U.S. ETF AUM, while broker-dealers, wirehouses and private banks each claim $385 billion of the total U.S. AUM.
“The total fee-based market is actually one-third the size of the wirehouse market right now,” Roame said. “That RIAs have more money in ETFs tells you that they have deeply penetrated with ETFs.”
Tiburon’s research found that RIAs were almost twice as likely to use ETFs than wirehouse brokers and independent representatives.
Institutional investors and advisors are claiming a larger share of ETF assets, Roame said, with Tiburon’s research indicating that institutional market share has grown from 24 percent of ETF assets in 2000 to 59 percent of ETF assets in 2015.
Despite the growth trends, the financial industry still might be overestimating the size and growth of the ETF market and the demise of the mutual fund, Roame said.
“There’s no way they’ll pass mutual funds in five years. It’s not realistic,” he said.