ETF Competition Is Good For Investors

The ETF industry is more competitive than ever, and that’s great for investors.

Reviewed by: Spencer Bogart
Edited by: Spencer Bogart

The ETF industry is more competitive than ever, and that’s great for investors.

Historically, the ETF industry has been highly concentrated, as key players such as BlackRock’s iShares, State Street Global Advisors, Vanguard and Invesco PowerShares have dominated the industry.

They’ve done well by investors too: The big players unveiled groundbreaking products and nurtured the young ETF industry by raising awareness and educating investors.

However, sometimes it takes the incredibly productive force of competition to unleash the next wave of innovation. That’s exactly what's happening in the ETF industry—and investors are winning because of it.

The Herfindahl-Hirschman Index (HHI) is often used as a measure of industry concentration. It is commonly used by anti-trust regulators to assess the effects of a potential merger on industry concentration. In short, it’s a proxy for measuring how competitive a given industry is.

The calculation is straightforward: Take the market share of industry players, square each and add them all up. Results range from zero to one—one indicates a monopoly (highly concentrated) whereas zero indicates a highly competitive industry.

Gradations arise between zero and one. A few examples of HHI readings and their implications are as follows:

  • Greater than 0.25 indicates a highly concentrated industry (lack of competitiveness)
  • Between 0.15-0.25 indicates a moderately concentrated industry
  • Less than 0.15 indicates an unconcentrated industry (very competitive)

1_Herfindahl Index by Asset Class

Returning to ETFs, over recent years, the industry has become increasingly competitive in nearly every asset class (save alternatives), as smaller challengers have snagged business from dominant incumbents.

The greatest concentration declines occurred in asset classes that were extremely concentrated as recently as two years ago: fixed income, asset allocation and commodities.

Nowadays, new entrants must pass an ever-higher bar to overcome the economies of scale that benefit the industry incumbents. To stay afloat, newcomers must find new ways to create value and innovate. And they have … in spades.


Product Innovation

Take, for example, the new ETF shop Cambria Funds, run by Mebane Faber, that offers an actively managed strategy (SYLD | B-46) that seeks to maximize shareholder yield at a time when yield is particularly hard to come by. Despite launching a short nine months ago, the fund has nearly $200 million in assets—more than enough to keep it afloat.

Other examples include the groundbreaking LocalShares Nashville Area ETF (NASH), which focuses its investing on companies in the greater Nashville area and the Renaissance IPO ETF (IPO), which takes a new tack on IPO investing.

While the intellectual challenge of creating products that generate value for investors is greater than ever, one firm has simplified the administrative task.

Exchange Traded Concepts markets its “ETF-in-a-box” approach, and helps smaller firms bring new products to market by leveraging economies of scale in administrative, legal and other tasks. Several funds have been launched under the Exchange Traded Concepts umbrella, including the 2013 launches of a forensic accounting ETF (FLAG | C-70) and a robotics and automation ETF (ROBO).

Even established stalwarts must continually innovate to stay relevant in the rapidly evolving ETF industry. Recognizing the demand from investors for products that invest in international equities without international currency exposure, several of the big players released new products or popularized old currency-hedged strategies.

WisdomTree, an eight-year veteran of the ETF industry, even launched the world’s first negative-duration ETF last year, as investors prepared for the Fed "taper" and rising interest rates.

All this competition is good for investors who get access to the same products at a lower cost and/or access to new strategies that have never before existed in an ETF wrapper.

Some of the strategies that are now available in an ETF wrapper for all to access were previously only available to “accredited” (wealthy) investors and banks.

ETFs My Grandma Could Use

My grandmother can get into a covered-call strategy on the S&P 500 within minutes. She doesn’t know what that means, but she definitely appreciates the extra income each month and, importantly, the product has been deemed appropriate by her financial advisor.

In short, the range of strategies and products in the fertile ETF industry is a boon for all, as investors can easily and cost-effectively tailor their investing approach and exposure.

Of course, with so many choices, the challenge of selecting the right ETF is particularly salient, and that’s why a good screener and due diligence tool is critical.

The exciting part is that with an increasingly competitive, and growing, ETF industry, we’re likely to see several more waves of innovation. Will we see the launch of the proposed bitcoin ETF? Will nontransparent active ETFs earn regulatory approval and shake up the market?

Stand by—only time will tell.

At the time this article was written, the author held no positions in the securities mentioned. Contact Spencer Bogart at [email protected].


Spencer Bogart is head of research at Blockchain Capital.