BlackRock made a big splash in the exchange-traded funds business this summer with its $13.5 billion purchase of the investment unit of Barclays Global Investors, and analysts and executives are waiting for the next shoe to drop.

"The $64,000 question is, who will be the next large entrant into the space," said Geoffrey Bobroff, the president of Bobroff Consulting in East Greenwich, R.I.

Anthony Rochte, a senior managing director at State Street Global Advisors, said that since introducing the first ETF in 1993, State Street Corp. has watched the industry's success encourage a wide range of companies to enter the market. "This trend is a testament to how ETFs are changing the way financial advisers and investors construct and manage portfolios," he said.

A survey by State Street indicates ETF industry assets totaled $640 billion at July 31 after a $47.4 billion rise in July. At July 31, there were 750 ETFs, up from 538 two years earlier. State Street has launched six ETFs this year. It now has $153 billion of assets under management in 86 ETFs.

As more funds are rolled out, Rochte said it is vital that investors have the tools to evaluate ETF providers, the product's structure and its costs. "Despite the industry's growth, ETFs remain an emerging investment class with plenty of room for additional expansion," Rochte said. "In fact, many industry experts have projected a 20% to 30% annual growth rate for the foreseeable future. One of the keys to reaching this projection is better investor education."

Bobroff noted that Pacific Investment Management Co. has started fixed-income ETFs and some actively managed ETFs; Charles Schwab is expected to unveil some ETFs soon. Vanguard Group, the third-largest ETF provider behind BlackRock and State Street, recently came out with a group of fixed-income ETFs.

"The real question is how many fixed-income ETFs can the market absorb and still provide enough assets for the vendor to have a viable product," Bobroff said. "It is clear on the equity index front we have far too many ETFs, with the majority [in numbers, not assets] not viable and needing to be merged or liquidated."

The ETF industry business will face challenges from regulators, he said. The Securities and Exchange Commission, Financial Industry Regulatory Authority and various state regulators are attacking leveraged ETFs as being difficult for investors to understand.

Nonetheless, Rochte said State Street expects to continue roll out ETFs in underserved markets, including fixed income, this year. Bond funds make up 28% of mutual fund assets but just 13% of ETF assets, he said. State Street has also applied to the SEC to start a series of actively managed ETFs, Rochte said.

Michael Latham, chief executive officer of iShares, said the most significant trend is the growing use of ETFs in core investment portfolios. "All signs point to growing investor interest in ETFs, with more prominence [for] the products in 401(k) plans, 529 plans, managed accounts and more," he said.

Doug Dannemiller, a senior analyst at Aite Group, said ETFs will continue to take share from mutual funds because they are less expensive and easier to buy. "ETFs are facing some regulatory pressure on leveraged and inverse fund strategies, but I believe these strategies will withstand the regulatory review," he said. "Suitability is the key-these strategies are not for everyone -but they certainly do perform a useful function when deployed properly."

Dannemiller said ETFs are moving into the retirement savings arena and should gather assets as they become an accepted option in 401(k) plans. "ETFs coupled with professional advice on asset-class allocation are a step above the target-date mutual fund solution and are cost-competitive," he said.

But Bobroff said the ETF market is saturated and many of the commodity ETFs have become the latest day-trading vehicle. "We might see more players try to enter, but I would suspect that someone like Pimco or BlackRock may try to challenge the rulings that only Vanguard got that allows them to hang an ETF class off an existing fund," he said.

Those hoping to sell their business are rushing to claim turf, Bobroff said, but many of these parties may not be viable.

Latham said that, in recent years, an "arms race" has prevailed, with new companies launching products as fast as they can, touting bells and whistles but also taking risks many investors do not understand.

"While there has been a land grab underway in the ETF space," he said, "recent consolidation indicates the importance of an established provider. Scale, skill and support will determine the dominant players."


(c) 2009 Money Management Executive and SourceMedia, Inc. All Rights Reserved.

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