This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article features Joe Smith, CFA, senior market strategist at Omaha, Nebraska-based CLS Investments.
Have you ever wondered what goes into determining whether an idea is good enough to become an ETF? As the ETF market continues to expand with new product launches almost every few days, one could argue it doesn’t take much to turn someone’s ideation into another exposure trading as an ETF.
Speaking from experience, what used to matter for launching ETFs doesn’t seem to matter anymore. At one time, first-mover advantage was a big deal. It’s not so much anymore.
Providing access to an untapped segment of the market was considered innovative. I would argue just about every asset class is now covered. Fees weren’t a big part of the investment consideration. Now they are the lead reason some investors choose to buy an ETF.
The ETF industry, in many ways, is following a similar path to that of the technology industry. The market has gone from pure innovation and differentiation to the “copycat” app business. Most ETFs on the market are all playing in the same place with just minor variations of each other.
Does that mean the party is over? I would say definitely not. ETFs will continue to benefit as traditional active offerings and high-priced mutual funds bleed assets due to regulatory winds and client dissatisfaction with their overall experience.
The elephant in the room, however, is whether or not there is enough space for 15 different versions of the same flavor of ice cream. In fact, growth levels in some segments of the ETF industry, such as smart beta, seem to have already peaked and have been in slow decline since 2014.
Going forward, we all should expect a fair bit of consolidation to hit the ETF space. Economic theory suggests that, as more and more participants step in, the overall profitability associated with launching ETFs as a whole should decline. There will be clear winners that deliver scale and efficiency in their endeavors and others that falter because they aren’t able to get distribution and asset growth right.
I believe what will be required for those to remain on the battlefield will be an overhaul in distribution methods and education associated with ETFs. Technology has made it possible for touch points between product provider and investor to occur in-person and digitally. As someone who personally consumes information from either my iPhone or laptop, much of what I need to know about a new ETF is acquired long before I ever speak to anyone at the actual ETF provider’s offices.
That technology also means clients have the opportunity to educate themselves on what really matters when evaluating ETFs on their investment merit. Education will be less about what an ETF is and how it works, and will focus on whether investors are gaining the expected exposures and risk/return capture advertised. So far, very few comprehensive tools and analytics from the ETF community are broadly available for investors to easily and sensibly conduct these types of compare-and-contrasts.
Overall, ETFs continue to be a value-add proposition for investors. Competition provides innovation but will only provide long-term benefits to investors after long after periods of consolidation.
CLS Investments is a third-party investment manager and ETF strategist. It began to emphasize ETFs in individual investor portfolios in 2002, and is now one of the largest active money managers using exchange-traded funds. Contact CLS Senior Market Strategist Joe Smith, CFA, at 402-896-7823 or at [email protected]. Please click here for a complete list of relevant disclosures and definitions.