After two decades of massive growth, the ETF industry's
momentum may just be starting, PwC asserts. The market research
firm forecasts the industry's assets under management will
explode to $5 trillion from $1.7 trillion now in the next three
to five years.
Bill Donahue, managing director at PwC, explains major trends
shaping the industry's growth and its inevitable growing pains
noted in the firm's report, "The Next Generation of ETFs."
To what do you attribute the widespread growth of ETFs?
ETFs are attractive to individuals, intermediaries and
institutional investors alike because of their key
characteristics: liquidity, transparency, low cost, tax
efficiency and intraday pricing.
Additionally, passively managed ETFs were well-suited for the
increased scrutiny of costs and more widespread acceptance of
indexing as a philosophy over the past few years. ETFs helped
meet the demand for many investors for greater liquidity and
transparency in the aftermath of the financial crisis.
The migration of U.S.-based investment advice toward a
fee-based model has worked in the favor of ETFs, which provided
investment advisers with a convenient and effective means of
constructing customized client portfolios across a liquid and
diverse series of asset classes.
ETFs offer a convenient way to adjust portfolio exposure on
many fronts, including geography, market capitalization, industry
sectors, credit quality and duration.
Over the past few years, there has also been significant
product innovation for ETFs, with expansion into fixed income,
commodity and balanced-asset classes, which have been very well
received by investors. The recent introduction of ETF strategists
who research, design and manage portfolios of ETFs has created
expanded ETF offerings and contributed to the growth of ETFs.
Many ETF sponsors have expended significant efforts on
investor education over the past few years, which have helped to
generate further interest in their products. A number of online
brokerages over the past few years started offering low-cost or
commission-free trading, making it easier and less expensive to
How did you come up with your forecast that ETF assets will grow
to $5 trillion in the next three to five years?
Global ETF assets under management total about $2.4 trillion
currently. There are significant growth opportunities in a number
of different areas over the next few years:
1. Move away from commissions on a global basis toward
asset-based compensation, resulting in investment advisers
focusing more on asset allocation rather than security selection,
which should favor ETFs.
2. Opportunities for ETFs in the defined contribution
3. Expanded opportunities for ETFs in Hong Kong and China once
they have worked through a mutual recognition platform.
4. Further expansion of the U.S. active ETF market.
5. Expanded use of ETFs by both institutional and retail
What inevitable growing pains will the industry face?
As ETFs continue to grow, the current infrastructure and risk
oversight mechanisms will be tested. While the mutual fund
industry relies on an infrastructure that has proved resilient in
a range of market and economic challenges, the ETF infrastructure
is relatively new and is just now being tested with significant
assets, both in the U.S. and globally.
While ETFs have been around for more than 20 years, there
continues to be a lack of technical understanding of how they
work and how they can be used as a part of an investment
strategy. ETF sponsors will need to continue to focus on investor
education, including thought leadership and content marketing to
further the understanding of the technical details related to
their ETF lineup.
What are the regulatory challenges ahead?
ETFs have been extensively scrutinized by regulators for many
years. While there has been some recent easing around the use of
derivatives and self-indexing recently in the U.S., there
continue to be regulatory challenges of one kind or another in
almost every market around the world.
U.S. active ETFs have been around for a little more five years
and have reached approximately $16 billion AUM (assets under
management). The requirement to provide daily transparency of the
active ETF portfolio holdings is likely affecting the development
of active ETFs.
The SEC is also focusing on new and emerging risks for
1. The growing use of alternative and hedge fund
2. Whether boards, compliance personnel and back-office
functions are appropriately staffed and financed to cope with
3. Compliance with exemptive relief orders and the use of
custom baskets and compliance with regulations when
ETFs in Europe and Asia trade and settle on a national basis.
The resulting inefficiencies increase the cost of ETFs.
However, in both Europe and Asia, recent developments may
potentially reduce trading frictions and improve liquidity and
reduce the costs of trading ETFs.
Hong Kong and China regulators continue to work on the details
for a mutual recognition platform for public funds to be sold
directly in each market.
These two jurisdictions have different trust laws, fund
distribution regulations and post-sale servicing practices, which
have to be aligned prior to the launch of the mutual recognition
What do you see as the biggest trends shaping the industry?
1. Continued expansion of the ETF strategists.
2. More focus on solutions-oriented ETFs, including fixed
income and active funds.
3. Upcoming regulatory and policy changes likely boosting the
distribution of ETFs in Europe and Asia.
4. Significant growth for active ETFs.
5. Continued focus on investor education and distribution
6. Global expansion of ETF sponsors in pursuit of growth and