U.S. ETF Assets Hit $1 Trillion Milestone

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Assets in U.S. ETFs reached $1 trillion on Thursday, a major milestone for an industry that began 17 years ago with the launch of the SPDR S&P 500 ETF (NYSEArca:SPY) on Jan. 29, 1993.

The original designers of SPY thought the ETF would appeal only to traders; indeed, it was initially designed in large part to bring new trading volume to the (now defunct) American Stock Exchange.

SPY eventually did prove successful with traders, but the audience for ETFs has expanded to include everyone from retail investors to the largest institutional investors in the world.

SPY, now with almost $92 billion in assets, sits atop a universe of more than 1,100 funds that's already poaching market share from actively managed mutual funds. Indeed, mutual fund sponsors have lined up at the Securities and Exchange Commission in the past year to obtain permission to launch ETFs, and their arrival on the ETF scene could be a huge development in the industry.

Much has changed since the SPY launched in 1993, especially the money management industry itself, where commission-based stock pickers have been surpassed by fee-based asset managers who view thoughtful asset allocation using low-cost vehicles, increasingly ETFs, as the best way to deliver solid risk-adjusted returns at the right price.

"Costs certainly matter, and clients have certainly taken notice," said Rick Genoni, head of ETF strategy at Valley Forge, Pa.-based Vanguard Group, now the No. 3 U.S. ETF firm.

"Frankly we've only just scratched the surface on the opportunity here, and I think that's true for the industry," Genoni added, noting many advisors-and clients who don't use advisors-still don't use ETFs in a meaningful way.

Yesterday's final push over the $1 trillion mark, appropriately enough, was led by $10 billion in U.S. equity creations and included $8.3 billion of inflows into SPY itself, according to data compiled daily by IndexUniverse.com. The data include all exchange-traded products, including exchange-traded notes, though the vast majority of assets are in ETFs.

Exceeding Expectations

Nate Most, the ETF executive at State Street Global Advisors widely credited with conceiving the idea of an exchange-traded fund, never imagined the ETF universe could expand past more than five index funds tracking the biggest U.S. equity benchmarks, according to James Ross, head of ETFs at SSgA.

Ross said the ETF's trajectory, from its conception as a simple trading vehicle to its role as the centerpiece of so many core and satellite asset allocation strategies, is nothing short of amazing.

"The ETF is one of the most innovative, if not the most innovative, development in the financial markets in the last 20 years," Ross said in a recent telephone interview.

"Looking at the landscape and seeing how it's changed-we now have everything from domestic, international, emerging, fixed income, commodities currencies, active. You can see how it's going to propel itself forward in the future," he said.

Still, countless sources-fund sponsors, advisors and industry consultants alike-tempered their optimistic outlooks with calls to make ETF education one of the industry's central concerns, even as "exchange-traded fund" gradually becomes a household word.

"The real challenge today is that many people-journalists, bloggers, analysts, etc.-just call everything an ETF," said Deborah Fuhr, a London-based managing director in charge of ETFs with BlackRock, which owns the world's biggest ETF company, iShares. "Sometimes the products are structured as funds, sometimes they're structured as partnerships, or notes or grantor trusts, and that can imply different tax or regulatory implications."

"Some people spend more time selecting a TV than they do when they're looking at some of the investment products that are out there," she continued, stressing that investor education is more important than ever, since products haven't grown any simpler as they become more popular-in fact, much the opposite.

Tipping Point

According to recent studies by Schwab and by TD Ameritrade, only 15 percent of all U.S. retail investors now use ETFs. Those two studies reflect just how much potential the ETF industry has for future growth.

The critical question is whether the mutual fund industry will decide it can no longer sit on the sidelines as ETFs steal their market share and roll out their own ETFs in a big way.

To be sure, the $1 trillion now in ETFs is a drop in the bucket compared with the $11.5 trillion in U.S. mutual funds as of the end of October, according to Investment Company Institute data. So, few believe the pressure is really on quite yet to switch to ETFs, although the mutual fund industry will surely take notice of the $1 trillion milestone.

But already there are incipient signs that ETFs are stealing market share from mutual funds. For example, last summer, when volatility gripped the markets due to Europe's sovereign debt crisis, equity mutual funds experienced outflows, while ETF asset flows treaded water or even remained positive.

"We'll probably get to a tipping point somewhere," said Dan McCabe, president of Next Investments, a New Jersey-based firm that helps companies bring ETFs to market. "I don't know if $1 trillion is it; it might be $2 trillion, but you're going to come to some point where you see the flows moving more rapidly out of one environment and into another."

Some firms already have begun the process of incorporating ETFs into their product mix along with mutual funds.

BlackRock bought its way into the ETF business with its purchase of iShares, as did Guggenheim with its acquisition of Claymore Securities. One firm, Ohio-based Huntington Bancshares, has plans to change some existing mutual funds into ETFs; while others, like fixed-income powerhouse Pimco in Newport Beach, Calif., have steadily added ETFs to their pre-existing lineups of successful mutual funds.

Vanguard, a pioneer in the world of index investing, simply made ETFs a different share class of its existing mutual funds. What's more, the firm, founded by John Bogle, also uses Wellington, a firm known for its actively managed mutual funds, as one of its independent external advisors.

Not only is Vanguard's Emerging Markets ETF ( VWO ) the most successful U.S. ETF this year, but the Pennsylvania firm, like BlackRock and Guggenheim, can provide both passive index and actively managed products to an investing world that may never settle which, if either, of the two investment philosophies is better.

Active ETFs?

The endless passive vs. active debate may be more than academic in the world of ETFs. That's because nearly all the big mutual fund firms filing to offer ETFs have proposed lineups of actively managed funds.

The problem with active ETFs is that the ETF, as currently designed, is a fully transparent vehicle that's required to disclose its holdings on a daily basis. Active managers usually want to protect their "secret sauce" of good investment ideas, but regulations don't allow it.

A fair amount of energy is being devoted to reconcile this problem, as a recent licensing deal between a Boston-based mutual fund firm and longtime ETF industry player Gary Gastineau suggest. Gastineau, president of New Jersey-based ETF Consultants, recently sold Eaton Vance a group of patents focused on how to develop nontransparent actively managed ETFs. Meanwhile, Eaton Vance filed "exemptive relief" papers in March laying the groundwork for the launch of five fixed-income ETFs.

If this idea of nontransparent, actively managed ETFs takes off, it could give Eaton Vance and other firms filing for exemptive relief-such as Legg Mason, Alliance Bernstein, Dreyfus and Janus-the impetus necessary to jump head first into ETFs. That, in turn, could open the floodgates for ETF asset growth.

"Everything in the ETF industry is about when , not if ," Lee Kranefuss, the former head of iShares, the world's biggest ETF company, told IndexUniverse.com in a telephone interview. The firm now commands about 45 percent of the $1 trillion in assets under management.

"The ETF is just a much more appealing package," Kranefuss added.

Top 10 Creations (All ETFs)

Top 10 Redemptions (All ETFs)

ETF Daily Flows By Asset Class

Top 10 Volume Surprises, Funds >$50 mm AUM

Top 10 1-Day Performers, Excluding Leverage/Inverse Funds and >1,000 Shares Traded

Bottom 10 1-Day Performers, Excluding Leverage/Inverse Funds and >1,000 Shares Traded

Disclaimer:All data as of 6 a.m. Eastern following the day noted in the headline. Data is believed to be accurate; however, transient market data is often subject to subsequent revision and correction by the exchanges.

Don't forget to check IndexUniverse.com's ETF Data section.

Copyright ® 2010 Index Publications LLC . All Rights Reserved.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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