In the U.S., first mover-advantage has been a key to success among ETFs, and those providers who have showed up late to the party may be doomed for failure unless they find ways to overcome high barriers to entry.
On the opposite end of the spectrum, Asia - a significantly less mature market - is where opportunities abound, according to Matt Forstenhausler, EY's global wealth and asset management ETF leader.
Based on new EY research performed across 21 cities throughout the U.S., Europe and Asia, Forstenhausler discusses how ETF providers can best access the Asian market, why liquidity is what sets ETFs apart from other regulated and pooled investment vehicles and more.
Q. Your report shows that ETFs continue to grow rapidly, but few markets will follow the U.S. model. Why is that?
Retail customers account for approximately 50% of the U.S. ETF market, much higher than other markets However, they account for only 10% of the European ETF market. The U.S. market is much more influenced by the needs and purchasing habits of retail customers, and is much more concentrated on the three major exchanges.
The Asian market shows the fastest growth rates across the globe. Overall, Asia is more open than the U.S., in terms of the concentration levels within the top players. Asia is also a more fragmented market, with country / brand loyalty, and many different countries, currencies and tax jurisdictions. The biggest challenge for international / local players in Asia is how best to access Asia and transact across borders.
Q. According to your findings, the industry's success depends on delivering liquidity in good times and bad. Why is liquidity the most distinctive and important feature of the industry?
Liquidity is what sets ETFs apart from other regulated and pooled investment vehicles. ETFs can be bought or sold on the stock exchange at something close to NAV throughout the day. Open end mutual funds can only be bought or sold after the end of each business day at the closing NAV. While closed end mutual funds can be bought or sold on the stock exchange throughout the day, the absence of the Creation Unit process allows the closed end fund stock exchange price to vary (sometimes significantly) from the NAV.
Q. How is innovation vital to successful fund launches?
Because most U.S. funds are listed on either the NYSE or NASD, there is very little market appetite for duplicate ETFs. Existing ETFs have "first mover advantage" and are able to attract a significant amount of assets producing lower expense ratios that create high barriers of entry for new ETFs. In Europe and Asia there is more country / brand loyalty and several ETFs may exist tracking the same indices. Being first-to-market is still an advantage, as promoters compete for new assets.
Accordingly, only new and innovative ETFs can be expected to gather new AUM. Innovation must be carefully done because new investors may not invest in poorly planned or designed products.
Q. Attitudes to pricing are becoming more sophisticated as ETF markets develop. Globally, management fees are seen as a slightly less important differentiator than last year. Why?
The U.S. market is more mature and costs are more closely scrutinized. In Asia, cost is still less of a focus than in the U.S. This is due in part to the markets being at earlier stages of growth. As the industry becomes more competitive we expect the focus on management fees to increase.
Q. According to your research, large firms will switch focus to entering new markets and launching new products. Please explain.
As markets mature, there is less room for new ETFs. For example, how many S&P 500 ETFs can there be? Again as above, first or early-to-market advantage is key.
Q. Predictions of consolidation at the promoter level are declining. What is the reason for this?
There is a recognition that players in the market are looking for long term profits. There will, however, be more forced exits from the market as promoters struggle to make low margin business profitable. These businesses are not likely to be acquired unless a buyer can identify a clear business opportunity.
Q. How will fund companies improve distribution?
The preferred distribution channel varies by region. In the U.S., it is the increased number of platforms with a focus on retail investors. In Europe it's the increased dedicated sales forces actively selling these products in individual countries. While in Asia, it will be a focus on media advertising to get to end retail investor.
Q. What are the three single most important takeaways from your findings for mutual funds/ ETFs?
a. Better liquidity through efficient central / cross border settlement will unlock latent growth in the industry. This is particularly relevant for Europe and Asia. Better liquidity will increase institutional investment and this will then improve liquidity, further attracting retail investors.
b. Growth rates will be achieved by taking market share from other passive products. ETF promoters do not necessarily view other ETF promoters as competitors. There is rather a view that if the overall industry grows, everyone will benefit. Innovation is also key to achieving growth rates as providers seek to be creative to seek first-to-market advantage. We expect the Asian ETF industry could surpass the hedge fund industry in size over the coming 12 to 24 months.
c. The industry is becoming more competitive across the globe as the industry grows in size and complexity.
Q. What from your research most surprised you?
Expectations on management fees - globally investors are becoming more educated and understanding that management fees may not represent the full cost of investing. Hence the outlook for management fees looks relatively stable.
Overall, there is a continued good news story in terms of growth levels. There are continued expectations of growth and everyone surveyed, without exception, expects the industry to continue growing.