The U.S. ETF and ETP industry capped 2014 by reaching the $2 trillion mark for the first time, surging on increased popularity among institutional and retail investors.

But in 2015, much of the industry's growth outlook will depend on how competition fares between the cascade of funds entering the market, currency hedging and smart beta trends, and the momentum new non-transparent ETFs can gain with investors and offerings.

ETF and ETP assets increased 18% in 2014 from $1.698 trillion to $2.007 trillion on Dec. 22, based on positive market performance and net new assets, according to London-based research firm ETFGI.

ETFGI reports that the U.S. listed ETF and ETP industry gained $232 billion in net new assets in 2014, which is a new record, topping last year's haul of $190 billion.

"The $2 trillion asset milestone in the U.S. is significant because it reconfirms that the adoption of ETFs is a multi-decade trend impacting the asset management industry, and not a temporary, cyclical development," says Aniket Ullal, founder of San Mateo, Calif.,-based First Bridge Data, a provider of independent ETF data and analytics to institutional clients.

"It indicates that ETFs continue to take market share away from traditional mutual funds in the U.S., and that they have been adopted by a wide segment of investors including both retail and institutional investors."

SLOWER GROWTH?

Despite the asset milestone achieved, Ullal says ETF market watchers need to be conservative in their growth estimates as they look ahead into 2015.

"Asset growth is driven by two factors - a shift to ETFs away from other products such as mutual funds, and market appreciation," he says. "The first trend seems likely to continue, but the latter is, by definition, difficult to predict and may not match the appreciation of the last two years.

"It is difficult to speculate on what the asset total will be by the end of 2015. A reasonable guess is that ETF product introductions will continue at an aggressive pace, and that total assets will continue to grow but at a lower rate than in 2014."

KEY TRENDS

Key trends and developments in 2014 may provide an indication of what 2015 holds for ithe industry Ullal says, listing several points in particular:

  • Increased adoption of 'smart beta' ETFs that don't use traditional market cap weighting, such as high quality, minimum volatility and momentum ETFs.
  • The introduction of more specialized products and niche strategies in each asset class.
  • The continued success of currency hedged ETFs for international equity exposure.
  • The entry and expansion into ETFs by traditional active management firms such as Fidelity.
  • The SEC's approval of Eaton Vance's application for a non-transparent, actively managed Exchange Traded Mutual Fund (ETMF).
  • The fall in crude oil prices that helped some ETF categories, including retail and airlines while hurting others, specifically Russia and energy.

Ullal expects that many of the 2014 trends such as the adoption of smart beta ETFs and currency hedging will continue into 2015.
"The most important thing to watch for in 2015 will be the activity on non-transparent ETFs," he adds. "With Eaton Vance getting approval for the ETMF structure, it seems likely that some non-transparent ETFs will get introduced in 2015."

WINNERS & LOSERS

The market appetite for ETFs has meant a flood of offerings as providers try to capture investors. In 2014, there were 204 ETFs launched in the U.S., Ullal says. 

Some 2014 launches found immediate success in the market.

First Trust Enhanced Short Maturity ETF, First Trust Dorsey Wright Focus ETF, UBS AG FI Enhanced Large Cap Growth ETN, Credit Suisse FI Large Cap Growth Enhanced ETN and iShares Currency Hedged MSCI Japan ETF all crossed the $250 million asset milestone in the year of their launch.

However, overall only 22 of the ETFs launched in 2014 (just over 10%) had assets above $100 million by the end of November, Ullal notes, and five ETFs launched in 2014 were also shut down by the end of the year. "This shows the long odds that any new ETF faces in a crowded and competitive marketplace."

In 2014, 77 U.S.-listed ETFs were closed, Ullal says. "However these closures represent a healthy pruning of product portfolios," he adds. "In 2015, we can expect to see a similar pace of activity. So in general, the U.S. ETF industry seems to be showing signs of healthy growth and early maturity, with some reasonable churn in launches, closures and new entrants."

MESSAGE RISK

The key challenge for the ETF industry will be to retain its core messaging, Ullal says. "ETFs have become successful because they are viewed as low cost, tradable, tax efficient and transparent. As the industry moves towards active and non-transparent ETFs, some of these attributes will get lost. For example, ETMFs will not announce their holdings daily.

"Similarly, many active ETFs have expense ratios that are close to or above 1%. So the biggest risk the ETF industry faces is a loss in the simplicity of its core message, which could hurt asset growth."

Related to this is the danger of product proliferation, Ullal adds. "While having product choice is good for investors, too many options can be confusing."

INNOVATION AHEAD

Ullal expects the biggest innovations are likely to come in the area of non-transparent ETFs, calling them a significant development since they will allow for traditional mutual fund providers to expand in the space.

"[But they are] unlikely to meaningfully disrupt the current market share dynamics in the next two years," he says. "We have seen that it is difficult for even very reputable active firms to come in and quickly or disruptively grab ETF market share - it takes time to get close to or above the 5% market share level.

"If a Bitcoin ETF launches, that could be another big innovation, though the ultimate prospects for the product are far from certain." 

Read more: