ETF Inequality

November 29, 2011

Income inequality has been in the news quite a bit lately, and it got me thinking about ETFs.

ETFs have always seemed, at least anecdotally, like a winner-take-all kind of product. One fund in a given market segment—say, biotech—will pull in huge assets, while other funds languish with just a few tens of millions.

The tendency for a few ETFs to dominate in assets is widespread throughout the industry and it’s more than just an odd quirk of the business: It hints at the future viability and growth of the ETF market.

To get a concrete measure of asset concentration, I turned to a metric that economists often use to compare the income distribution across countries: the Gini coefficient.

The Gini coefficient compares how income distribution in a population differs from a perfectly equal population. The measure is a number between 0 and 1, with a value of 1 representing all the money in the hands of a single entity.

To take some real-world examples, Sweden’s Gini coefficient is 0.23, while Brazil’s is 0.53.

So, what does the ETF market’s Gini coefficient look like?

Gini graph


A chart of the Lorenz curve of ETFs, used to derive the Gini coefficient. The red line represents what the curve would look like if assets were distributed equally among ETFs. The blue line is the true distribution of assets.


At 0.56, the ETF industry’s Gini coefficient falls somewhere between Brazil and Sierra Leone. In other words, assets are very concentrated—85 percent of ETF assets are held by just 5 percent of funds.

So why does that have me worried about the future of ETF innovation?

Take a look at today’s ETF market. We’ve seen an average of about one new ETF or ETN launched each day this year. That growth rate can’t continue forever, but that’s especially true if only a small percentage of those ETFs are truly profitable.

After all, ETFs make their money as a percentage of assets. So, if most ETFs attract very few assets, they may not be profitable. As it stands, a third of all ETFs have less than $16 million in assets, an amount that is likely unprofitable to most issuers.

Unless ETF assets as a whole rise significantly—a rising-tide-lifts-all-boats scenario—many of these funds could be shuttered.

That’s not a far-fetched scenario. Inside of the past 10 years, ETF assets have grown tenfold, so many of these funds may still attract enough interest to become profitable products in time.

It’ll be interesting to track how the distribution of assets evolves after the current growth period.

To my eye, though, it looks increasingly possible that the number of ETFs on the market will be smaller, not larger, a few years down the line.



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