Exchange-Traded Products' Popularity Means More Creativity, Competition and Caution

Investors can’t seem to get enough of exchange-traded funds and notes, a fact that has regulators on high alert and ETP providers racing to come up with ever-more creative offerings to differentiate themselves from the competition.

And while the worldwide ETP market has enjoyed astounding growth in the past decade – up from $146 billion in assets under management in 2002 to more than $1.5 trillion in 2011 – a new report from Celent concludes that regulatory issues, increasing competition both among vendors and investment products and the growing participation from the retail market will have a dramatic impact on the industry going forward.

Celent predicts total ETP assets under management will at least triple in the next six years to more than $4.5 trillion by 2017.

“The ETP market is becoming increasingly competitive, and more niche products are being created,” said Anshuman Jaswal, a Celent senior analyst and author of the report. “The potential for active ETFs makes this an interesting space to follow in the coming months.”

The report found that equity ETFs represent about 70% of the global ETP market right now with North American funds accounting for the lion’s share of the market. In fact, more than $1.15 trillion (of the roughly $1.5 trillion total) of assets are held in 1,392 ETPs run by 48 U.S.-based providers. Europe was an extremely distant second at $323 billion while Asia checked in third with $110 billion in assets under management.

Fixed-income and commodity-based ETFs today represent 17 % and 12%, respectively, of the total ETP pool.

And there’s every reason to believe investors’ infatuation with these funds will remain robust for the foreseeable future.

Earlier this month, BlackRock reported that ETPs attracted net new assets of more than $67.3 billion in the first quarter, a 57% increase from the $42.8 billion added in the fourth quarter of 2011.

But this tremendous growth and proliferation of new ETFs has regulators and even fund providers taking a closer look at what can be done to better educate investors who are hip to the sizzle of ETPs, but might not necessarily understand what’s in the steak.

Charles Schwab recently said it’s mulling whether or not to add a warning when a customer is about to trade certain exchange-traded products, a development that would result in one of the strongest warnings yet for retail investors intrigued by these fairly esoteric securities.

Besides the variety of options available to them, Celent’s report found that investors often favor ETPs over mutual funds because they generally deliver higher pre-investment returns and lower pre-tax expenses.

“This is one of the reasons that they have been successful in obtaining new inflows at a time when the level of inflows into mutual funds is either flat or declining,” the report concluded.

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Considering the ravenous demand, it’s no surprise that the ETF market is becoming more competitive. And this competition can be seen in different areas, according to Celent.

“The fees for managing ETFs have declined, and the trading commissions have also dropped in the last couple of years,” the report said. “Meanwhile, more niche products are being created. The mainstream market that tracks the leading indices has become saturated and fund providers are looking at creating new funds that operate in niche areas to attract customers.”

For better or worse, the retail market is starting to take more than a passing interest in ETFs.

“While the ETF market has been traditionally the domain of institutional investors, there has been an increase in interest in the ETF market from retail investors and we expect this trend to continue in the coming years,” Jaswal said.

And while the regulations are expected to become tighter over time, Celent said the ETF market would not be affected severely and that any new regulations would mainly be implement to ensure these highly popular products are not misused.

Larry Barrett writes for Financial Planning.

 

 

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