The Challenges—& Successes—Of Running An ETF Biz

January 11, 2017 Asset growth is great, but our data show that revenue growth is lagging, be it due to fee wars or due to investors’ focus on cost. Is running ETFs not much of a moneymaker? Is that a concern for an investment business like yours?

Thomas: It's important for people not to confuse the fees with the profitability. So I think one of the misnomers about ETFs is they're not a profitable business. I can assure you that leaders in the ETF business are profitable.

Without getting into too much detail, the reality is ETFs have a different cost structure than, say, mutual funds. There are certain costs to distribution and things like that you would associate with other structures that wouldn't go with ETFs. While there are a lot of new players who haven't gotten up to scale, I wouldn't characterize the business as being unprofitable, although I would say, on a fee basis, you have relatively lower fees when you're comparing to other kinds of structures.

Yes, there’s been fee competition, but it's been concentrated in what I would call the more traditional, or core, benchmark indices. Our product lineup—every single one of our ETFs—is an alternatively weighted or a nontraditional index, so our experience has been different. What hasn’t worked well in your experience as an ETF issuer?
We're long-term-oriented. To date, we have not closed a single fund, because we look at every one of our funds as having attractive long-term potential.

But we've learned there are parts of the market that take longer to gain adoption. Let me give you an example. There's a lot of understanding around quantitative index approaches on the equity side. Less so on the fixed-income side. We’ve learned that you can't just develop an innovative product. You have to be prepared for a sales cycle and an adoption cycle for certain strategies in fixed income to take longer than on the equity side. What’s your outlook for ETFs and the ETF industry?
We're seeing a lot more of the share of ETF flows go to fixed income. I don't think that's solely about people's concerns about risk, because it's across the risk spectrum in fixed income. It’s demand for fixed-income strategies that are innovative, that are built around empirically grounded and quantitative research—smart-beta strategies. That’s a trend we’re watching.

The second trend I see across asset management—not just unique to ETFs—is a push towards sustainable or impact investing. Exposure to what people refer to as ESG [environmental, social, governance]. We’re going to see two things on this front: First, there’ll be more and more interest in ESG-type strategies. Secondly, we’ll see more integration of ESG in other strategies. ESG may soon no longer be its own bucket in investor portfolios, but may be incorporated into new strategies everywhere.

The last thing in terms of the overall business is that we're at a point now where we've moved from what I would call the clear innovation stage to the growth phase. We're maturing as an industry. I would expect to see some consolidation and more shake-out. We’ll still see new entrants, but the barriers to success, different than barriers to entry, are high. The marketplace is becoming more discerning and increasingly competitive.

The good news is that we know people both on the advisor side and the institutional side are using ETFs more and more in a long-term fashion.

Contact Cinthia Murphy at [email protected]


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