While exchange-traded funds (ETFs) have for many years been viewed as disruptors of the traditional asset management business, we would argue that has yet to be the case. In our view, the biggest disruptor to active management over the last decade has been the poor relative investment performance of the group as a whole, which has only spurred on the secular trend toward passive investing.
With close to $2 trillion in ETF assets domestically, and the market for "plain-vanilla" index-based ETFs already in the hands of a few top fund providers, there has been an increased focus within the ETF industry on products that blur the lines between passive and active management. While it has been easy so far for most of the traditional asset managers we cover to ignore the growth of ETFs, as it has had relatively little impact on their economic moats, we think that will change as we move forward—especially if actively managed non-transparent exchange-traded products (ETPs) take off. At this point, only wide-moat BlackRock (BLK) and narrow-moat Invesco (IVZ) have had any real success in the ETF market, having bought iShares and PowerShares, respectively, during the last decade.
The global ETF market is too big to ignore. With just over $1.7 trillion in AUM domestically at the end of 2013, accounting for close to 10% of U.S. investment company assets, and with more than $2.4 trillion in AUM worldwide, the ETF industry commands a lot more attention these days. The U.S. industry remains on pace to pass the $2 trillion AUM mark this year, with global ETF levels approaching $3 trillion overall. The secular trend toward passive investing has fuelled the growth of ETFs. The U.S. ETF industry has benefited from the trend toward passive investing that took root more than two decades ago, greatly aided by the inability of a large percentage of active equity managers to outperform the market over that time, and the ability of ETFs to offer market returns for a substantially lower fee.
The bulk of ETF assets and growth has been concentrated in equities, with equity-based ETFs currently accounting for 79% of domestic ETF assets and picking up more than two thirds of the inflows into ETF products. We expect equity ETFs to grow organically at a high-single-digit rate in each of the next five years.
Six different factors should drive domestic ETF growth. In the near-to-medium term, US ETF growth should be driven by the increased use of ETFs in the retail-advised market and by self-directed and institutional investors; the expansion of ETFs as core holdings for both retail and institutional investors; the expansion of the fixed-income market for ETFs; and the launch of new products.
ETF strategies have begun to blur the lines between active and passive management. The rapid growth of ETF managed portfolios and strategic beta or smart beta products have highlighted the demand for hybrid investment vehicles that can meet different investor needs.
Few of the asset managers we cover have benefited from the growth of ETFs. Only BlackRock, the ownerof iShares, and Invesco, which owns PowerShares, have truly benefited from the growth of ETFs. While most have filed for permission to offer ETFs, only a few have either launched or partnered up on an ETF product. BlackRock remains our top pick among the asset managers we cover, and is the best way for investors to benefit from the growth of the ETF industry in the near-to-medium term.
