ETFs and diversification go hand in hand. The vast majority of ETFs are diversified baskets of securities. And with 2,302 different ETFs in the market today, building a well-diversified portfolio with ETFs is easy.
But here’s what’s funny: If the ETF industry itself were a single ETF, holding 2,302 securities in a portfolio weighted by assets, it would be a very concentrated, top-heavy strategy where five names represent 20% of the entire pie.
This month we watched the Invesco QQQ Trust (QQQ) reach a rather exclusive milestone: $100 billion in assets under management. The fund is now part of a rarefied team of giants that include four other ETFs boasting more than $100 billion each.
Land Of The Giants
The SPDR S&P 500 ETF Trust (SPY), the iShares Core S&P 500 ETF (IVV), the Vanguard Total Stock Market ETF (VTI) and the Vanguard S&P 500 ETF (VOO) each have anywhere from $130 billion to $257 billion in assets under management. Together with QQQ, these five ETFs boast a whopping $800 billion in combined assets, or 20% of all U.S.-listed ETF assets today.
A look at ETF issuers themselves tells a similar tale when it comes to concentration. BlackRock’s iShares manages just over $1.5 trillion in U.S.-listed ETF assets—or roughly 38% of the entire U.S. ETF market. Vanguard isn’t far behind, running about one-fourth of all ETF assets, with more than $1 trillion under management.
Diversification is cool. Diversification is really smart. Diversification is one of the key attributes of ETFs. But, boy, is this industry concentrated!
Scale & Liquidity
You could argue that it all comes down to investors. They aren’t really diversifying their ETF choices past big-brand value. Or you could argue that of all the heralded traits of ETFs—transparency, low cost, diversification, tax efficiency and tradability—it’s the latter, as it pertains to liquidity, they value most.
These massive ETFs have ample liquidity any given day, making getting in and out a breeze. The issuers behind them have massive scale that continues to grow every day.
But that’s not to say there’s no room for smaller issuers trying to carve out a niche in this industry.
Market Share Dynamics
For some perspective, consider that seven years ago, the top three biggest issuers already commanded 83% of all U.S.-listed assets. Last year in May, we saw that market share jump to 92%, but that was an outlier year. Every other year, the top three have managed about 81-83% of the ETF market, with smaller issuers battling it out for the other 15-20% or so.
With more than 120 different ETF issuers out there, there are plenty of Davids looking to battle the three Goliaths. The good news is that success in this business doesn’t necessarily involve dethroning the leaders.
Smaller issuers are, in fact, finding their way to the end investor. But it’s those that bring to the table a good value proposition—be it in the form of unique in-demand approaches, low-cost access or consistently strong performance—that stand out in the crowd. Just as important, it’s also those who are committed to putting shoe leather to work, getting in front of advisors and investors everywhere, selling the implementation case for their ETFs.
The Active Manager That Could
One example of a success story is ARK Invest. Cathie Wood, its founder and head, managed to create a small ETF shop that packs a huge punch as one of the only players today to show consistent success with active management.
With only seven ETFs in the market today, ARK has grown to $5 billion in total assets in just about five years. What stands out here is ARK’s research-driven, actively managed approach and bold, full-of-conviction bets that often go against the grain.
So far in 2020, ARK has seen its asset base grow nearly 40% between a mix of $1.2 billion in net new creations and strong performance of its funds. The young ETF firm is now the 21st largest issuer in the country and one of the most admired among the fearless, die-hard active ETF investors.
Defined Outcome Emerges & Shines
Another standout success story among the up and coming is Innovator ETFs. Everyone in this industry probably had a sit-down with founder Bruce Bond at some point in the past year—the firm’s commitment to boots-on-the-ground marketing is second to none.
But Innovator’s quick success is tied to its focus on defined-outcome investing—the first firm to really dig into this ETF segment—at a time when downside protection is all the rage. Among the firm’s biggest ETFs is the Innovator S&P 500 Power Buffer ETF – October (POCT) and its entire lineup of monthly Buffer ETFs.
Year to date, Innovator has picked up more than $900 million in fresh net assets, growing its asset base some 41% this year to just over $3.1 billion in total assets.
Can You Hear Us Now?
Defiance ETFs is another small player finding its footing with its strong next-gen thematic investing vein. The firm has seen more than $123 million in net asset inflows, which may seem little relative to the bigger players, but it amounts to 66% asset growth from year-end 2019. Defiance is behind three ETFs, the biggest being the Defiance Next Gen Connectivity ETF (FIVG). The firm today manages about $300 million in total assets.
At face value, it’s hard to get too excited about millions in net inflows when a firm like Vanguard has picked up more than $53 billion in net creations in the first four months of the year. But to a firm like Vanguard, those massive net inflows amount to a 4.7% asset growth rate from year-end 2019 levels—Defiance has grown more than 10x that this year in percentage terms.
Being a small ETF issuer in a market dominated by a handful of giants is not easy, but it can be done. As long as the smaller players bring out their best ideas, and get out there selling them with conviction, diversification in the ETF industry lives on, even if in a top-heavy game.
Contact Cinthia Murphy at [email protected]