We cover flows all the time, but you might be surprised where the revenue actually is in ETFs.
ETF flows tell us a lot—mostly about investor sentiment. Big flows mean enough buyers were in the market long enough to trigger creations. But with expense ratios as low as .03%, is anyone actually making any money in the ETF business?
Don’t get me wrong, I’m not asking to pour one out for the ETF industry, I just think it’s interesting to ask the question: Is anyone getting rich here?
I’ve run analyses like this before, usually focused on the question of which issuers were cleaning up. The methodology is pretty simple: You take the total assets under management in every fund, multiply that by that fund’s expense ratio, and you have what I call “implied annual revenue” from the fund.
That’s not, of course, exactly how much each fund contributed to the P&L of the issuer. Funds have expenses to pay, and some funds have acquired expenses to contend with, which really explodes the bottom-line expense ratio. And of course, funds have inflows and outflows, and markets go up and down. Still, as a back-of-the-napkin exercise, I think there are some interesting insights to be gleaned.
So here are some ways to break out the implied annual revenue of the U.S. ETF market. There’s not all that much at the top of the list. BlackRock, with almost 39% of the $2.6 trillion in ETF assets, takes almost 40% of the implied $6.443 billion in implied revenue for the U.S. ETF industry.
Profound Pricing Strategy Differences
But perhaps nowhere is the profound difference in pricing strategies more evident than in this table.
While Vanguard has 24% of industry assets, it takes in less than 9% of the till. Schwab, who’s risen rapidly into the top tier of issuers by assets, takes less than a percent of the revenue generated. That’s what a 0.03% product [the Schwab U.S. Broad Market ETF (SCHB)] does for your bottom line.
Conversely, firms like First Trust and ProShares, which are built on niche products with higher expense ratios, rocket to the top of the implied annual revenue chart.
I think looking at the bottom of the chart is almost as telling.
Most of these issuers are obviously quite new to the space, and are just starting to gather assets. But the next time I get an email suggesting the ETF space is easy to enter, I think I’ll show them this chart. Even firms that have had strong initial openings, like Nuveen and Davis, aren’t exactly covering their costs. It takes a lot more than $100 million to really carve out a nice business here.
But let’s peel the onion in some different ways. If you wanted to actually make money in the ETF business, what would you launch?
We’ll, let’s exploit my pathological love for pivot tables and find out...
With almost 80% of the assets, traditional equities make up the lion’s share of revenue, but I find it interesting how much of the pie is taken up by commodity ETFs. The majority of those assets are just in a handful of funds—the SPDR Gold Trust (GLD), iShares Gold Trust (IAU), United States Oil Fund LP (USO) and the like.
In fact, GLD alone accounts for $127 million in annual revenue out of the $333 million that commodities as a whole takes on. GLD continues to be the dominant player in the space, despite having an expense ratio 0.15% higher than competitor IAU. It’s nearly the definition of a cash cow.
In general, the “gut” sense that international and niche assets are better revenue generators per dollar holds out across the industry.
But what about “geared,” or leveraged and inverse, funds?
As a whole, levered and inverse funds make up a tiny part of the industry—under 2% by assets. But from a revenue perspective, they punch far above their weight class, pulling in almost 7% of all the fees in the business. And there doesn’t seem to be a clear connection between how much juice you’re offering up for how much extra revenue you can generate. The message is clear: People will pay up, a lot, for geared exposures.
The last bucket I was curious about was headline expense ratio. It’s been clear for several years now that the majority of flows, month after month, year after year, have gone into low-cost beta ETFs. But does this pan out when it comes to revenue? Put another way, if you were trying to make real money in ETFs, is it better to capture all that low-cost, simple beta money? Or to find a niche where investors are willing to pay more?
This is the chart that actually surprised me. While almost 65% of the assets are in funds charging less than 0.20%, that enormous chunk of assets accounts for less than 30% of the revenue. In fact, if you’re looking to get rich quick in the ETF business, it’s clear that you’ll do it a lot faster by charging north of 40 basis points, where the revenue/AUM ratios are well over 2:1.
Well, what about smart-beta ETFs? That was supposed to be a kind of panacea for investors and issuers—generating larger revenue streams while delivering better results for investors.
Using the FactSet “Strategy” designation, we can look at a wide variety of nonvanilla strategies and see how they work out.
It’s obviously not surprising that vanilla strategies generate the majority of revenue, and less than the assets would imply—most of the super-cheap strategies in the market are as vanilla as vanilla can be.
The more interesting discussion happens further down the list. Look at dividends! By assets, dividend strategies are well behind growth and value, yet they gain a huge premium on revenue. The interpretation here is clear: People will pay up, a lot, for income.
So is there a magic formula for “striking gold” in ETFs? Well, tongue-out-of-cheek, of course not.
Adding value to investors is the only magic formula there has ever been. But, looking at where the disparities are greatest, it’s hard not to suggest that being different is being rewarded. Yes, low-cost beta is important, and a driving force in asset growth. But firms that are providing unique products that meet unique needs can and do earn a rent far, far greater than the 3-basis-point bottom bar.
You can contact Dave Nadig at [email protected].