Exchange-Traded Funds Hit Their Stride as More Products with Different Exposures Come to Market

December 9, 2020 — Boston

ETF assets should multiply by the end of 2030. A virtuous cycle of adoption and innovation may add additional fuel.

The U.S. exchange-traded fund (ETF) industry continued to grow in 2020, reaching $5 trillion, despite the volatility attributable to the COVID-19 pandemic. As the industry grows—and it is expected to multiply over the next decade—issuers will have an opportunity to generate meaningful revenues through a greater variety of differentiated exposures beyond the commoditized core, according to Cerulli’s latest report, U.S. Exchange-Traded Fund Markets 2020: Broadening Product Use.

The ETF industry is undergoing a momentous shift. The majority (79%) of U.S. ETF issuers report that they are currently developing or planning to develop transparent active ETFs, despite only 3% of ETF assets being currently held in such products. On a category level, product development focus remains on U.S. fixed-income and U.S. equity products, despite such categories being most likely to be rated as product-saturated by advisors. Instead, issuers may seek to launch thematic and environmental, social, and governance (ESG) products, according to Cerulli’s survey. “These products allow for greater differentiation and appeal to younger investors and advisors,” according to Daniil Shapiro, associate director. Advisors are also more willing to use fixed-income ETFs (both passive and active), which are perceived to have proven themselves through COVID-19-related volatility.

Several catalysts will help grow active ETF assets. Driven by competitive market dynamics, eased regulation, and advisors’ willingness to use a wider variety of ETFs, the products offer issuers an avenue for differentiation. “As issuers increasingly perceive that the passive ETF landscape is product-saturated and fee-compressed, the ability to differentiate will be key to generating revenues,” notes Shapiro. Regulation—namely the passage of Rule 6c-11—makes it easier for issuers to launch transparent active offerings. Additionally, advisors indicate increased openness to using semi-transparent equity ETFs— according to the research, half of advisors now report they would adopt the products within three years. Cerulli perceives strong first-mover advantages and notes that issuers that wait to launch such products are giving up the opportunity to compete for an addressable market in the hundreds of billions.

As the ETF vehicle transitions beyond passive exposures, investors will be able to use it to achieve more of their financial objectives, and Cerulli suggests that issuers should think about their role in serving client needs across their lifecycle as much white space remains for innovative exposures. Still, market saturation for key exposures (including the opportunities targeted by semi-transparent equity ETFs) requires a calculated approach. “Successful asset managers will need to ensure that the products are launched with intentionality and targeting distinct market segments—and not simply based on the urge to act,” concludes Shapiro.

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