NEW YORK - Fund companies continued to introduce new exchange-traded funds throughout the past year, but the market will not be able to support an unlimited number of the new products, according to several industry executives.
The executives spoke at a forum on exchange-traded funds sponsored here by the Institute for International Research of New York, late last month.
A total of 57 new exchange-traded funds began trading in the U.S. last year, according to Morningstar of Chicago. One such fund has begun trading so far this year.
Exchange-traded funds are currently index-based and passively managed. At issue is the fact that there are only so many indices and only so many ways to slice them up, according to Donald Cassidy, a senior analyst with Lipper of Summit, N.J.
"I think we've gone fairly well down the list of major, recognizable indices and you're starting to see some duplications and multiples," said Cassidy. "I would think that there would be the potential that some of these might not trade very well."
The market does not have room for too many similar products that are only distinguished by price, according to Diane Garnick, equity derivatives strategist at Merrill Lynch of New York. As a result, a weeding out of exchange-traded fund products is expected to follow the exchange-traded fund boom that is occurring now, she said.
"I think the reason that many are of the belief that this is likely to happen is there are a finite number of ways that you can cut the market up into different slices, which is really what ETFs represent," said Garnick.
State Street Global Advisors of Boston and Barclays Global Investors of London both offer products that give investors access to the S&P 500. It seems as though that market is saturated with State Street and BGI competing on price yet more firms are coming out with S&P 500 products, according to Garnick. This redundancy will be even more common outside the U.S., according to John Prestbo, editor of Dow Jones Indexes of
New York. In Europe, Dow Jones has licensed five exchange-traded fund sponsors based on its two popular blue-chip indexes, the DJ Stoxx 50 and the DJ EuroStoxx 50, according to Prestbo. Despite facing regulatory obstacles in coming out with new products abroad, fund companies will continue to flood the market with exchange-traded funds, according to Prestbo.
"We will have true competition soon, where in the same geographic area you could have two locally-grown ETFs and one import all based on the same index, trading on different exchanges and competing for the same investment dollars," said Prestbo. "It is going to be a bush that has been not pruned very well and will be overgrown very shortly and we will have what is now occurring in the mutual fund industry, which is consolidation after the big explosion of funds."
Shares of similar exchange-traded funds have been forced out of the market before, according to Cassidy. One week after Barclays Global Investors introduced what are now its iShares, Morgan Grenfell of New York came out with nine "country baskets," which basically mirrored the iShares and traded on the New York Stock Exchange, according to Cassidy. The products were barely traded and lasted just nine months, he said.
"[ETF's] were not as well known then as they are now," said Cassidy. "ETFs are a story you read about every two days now, but I think the principle still applies. Why do we need multiple ways to trade the S&P 500? I have a hard time coming up with a very good answer for that."
While analysts foresee a weeding out process following the exchange-traded fund boom, it is too early to determine exactly how it will happen and how long it will take.
"I don't know that we've seen enough yet to know how it will work," said Prestbo. "It could very well be that some of these smaller sponsors of ETFs will themselves consolidate, thus providing a new impetus for withdrawal from the market. It's a little early to know how that's going to play out exactly."
