Editor’s Note: This article is the first in a five-part series addressing the distribution challenge across the ETF ecosystem, from issuers to advisors to home offices and end investors. Jillian DelSignore is principal at Chicago-based Lakefront Advisory, a firm focused on improving and scaling distribution strategies in the ETF industry.
This may surprise some, but there are 129 ETF issuers in the U.S. today—129! Some of these issuers offer one single ETF, and are likely names you’ve never heard of. Others are household names offering hundreds of funds.
Across these issuers, there are over 2,300 ETFs available to investors today. That number is still a fraction of the 9,400 mutual funds in the market, but we are going to see it continue to rise for two key reasons: 1) the adoption of the ETF Rule; and 2) the approval of multiple nontransparent ETF models.
ETF Floodgates Are Open
While you may not have read the ETF Rule word for word, one thing is clear: It is enabling ETF issuers to more easily bring their new products to market. This industry is one where innovation shines, and that innovation should continue and even accelerate, especially from some of the smaller issuers, as the timeline to launch ETFs shrinks and the playing field is leveled.
Nontransparent and fully transparent active ETFs are coming at us in much greater numbers than ever before. The approval of multiple nontransparent active models is going to drive product development in this unique area of “white space” in what might otherwise look like a saturated ETF market. More and more traditional mutual fund companies are entering the market looking to bring their active management capabilities into the ETF wrapper.
The bottom line is this: Ready or not, here they come.
While those two key regulatory changes are having an impact on the shape of the industry, there is another dynamic at play that is worth unpacking, and that is the accelerating rate of fee compression and the flocking to ever-cheaper products.
ETF expense ratios can vary widely based on many factors, including the exposure, issuer and structure, with some priced at over 1% and others at zero. While there is a wide range, investors are showing with their dollars that their preference is for the lower cost options. In turn, issuers launch cheaper and cheaper products in an effort to win the battle for those assets.
For example, in the equity and fixed income asset classes, which make up 95% of the ETF market, asset-weighted expense ratios fell to 0.17% and 0.18%, respectively, at the midpoint of 2020. Those numbers have come down every year at an increasing rate, and while a 2 or 3 basis point move might seem like splitting hairs, the trend of dollars moving toward the lowest cost option is clear, and the fee compression is here to stay.
Distribution: True Hurdle To Entry
What does all of this mean? Well, the regulatory changes are a positive for the industry and investors, as it levels the playing field and allows for more innovative products to come to market. The fee compression is generally a good thing for investors, as their cost to invest continues to go down.
But it also means that competition in the industry is increasing—rapidly. For issuers, it is getting that much harder to differentiate, to get noticed, to create brand awareness and ultimately to raise assets. Distribution matters more than ever.
Distribution is the thread that pulls the industry together. You’ve heard it before: ETFs are sold, not bought.
You can’t simply put your ETF into the market—regardless if it is the most innovative or cheapest out there—and expect it to jump off the shelf. Does that happen in a rare instance where market conditions are perfect for a certain exposure, and stars align and you see huge growth with what feels like little to no deliberate distribution? Sure. But that is definitely the exception to the rule.
It’s All About Access To Advisors & Investors
Access is key—access to those who will buy your product. That may sound simple, but it is getting more complicated by the day.
The advisor community has myriad options at their disposal—there are more issuers and products coming to market every day—so differentiating and raising awareness of your ETF and your firm is getting increasingly difficult, especially for smaller issuers.
Advisors are also inundated by product providers of all shapes and sizes, so it’s not just about what your ETF can do for them, it’s just as much about what you bring in the form of resources like portfolio construction tools, market commentary, practice management, etc.
That only comes up after you actually gain access to a particular set of advisors, which is getting more challenging as key home offices look not to necessarily add more products to their platforms, but instead to rationalize the size of the offering down.
Distribution Impacts All Parts Of Biz
In the end, you may create an amazing ETF, but it is getting harder and harder to get your ETF into the hands of those who want to buy it. Distribution is oh-so critical.
Distribution can mean a lot of things—external and/or internal salespeople, a digital strategy, especially in our more virtual world right now, etc.—but it all means that having a commercialization strategy day one matters.
In this short series, I will dig deeper to explore the distribution challenge facing issuers, advisors and home offices as we as an industry grapple with how to best get the growing number of ETFs into the hands of investors. We will end the series with a look into how model portfolios have grown in popularity and can potentially provide avenues for addressing this challenge.
I’d love to hear your thoughts and concerns about ETF distribution throughout this series. Reach out to [email protected]