ETFs' Future: Huge Growth

February 04, 2014


ETFs have always been a great hit with advisors and retail investors because they are low cost. Part of that is because they are index funds, and index funds are much cheaper to run than actively managed products. But part of it is the structure—after all, ETFs are cheaper even than traditional index funds.

How much cheaper? Well, the average large-cap equity ETF charges 44 basis points, and the average large-cap equity mutual funds charge 1.37 percent. That’s less than a 1 percent difference, leading some to ask, What’s the difference?

We think it’s enormous.

How Much Are ETF Investors Saving?

Let’s take just three asset classes: U.S. equity, international equity and fixed income. If you look at the simple average expense ratio of ETFs in each of these asset classes, and you look at the amount of money invested in ETFs, you’d have ETF investors paying about $7.2 billion in fees.

If that same money was invested in mutual funds, you’d be talking $21.9 billion in fees. To put it another way, ETFs are taking $14,761,866,000 every year out of the coffers of Wall Street and putting it into the pockets of investors around the world.

That’s $40.4 million per day, or about $500 a second. In the time it’s taken you to read this, ETF investors have saved about $50,000 versus where they would be if they invested in mutual funds. That kind of money matters.

But we all know that story. The story we don’t know is about institutions.

Institutions have always been big users of ETFs. But historically, they’ve had a very short-term focus. They’d use ETFs for what they call “cash equitization” and “transition management.”

That means if they had a bunch of cash—say, a new investment—and they quickly wanted to get exposure to the market, they’d park it in ETFs. Or if they were firing one active manager and didn’t know yet who they were going to hire as a replacement, they’d park it in ETFs for a while.

No self-respecting institution would take a long-term position in an emerging market ETF, because if they wanted long-term exposure to emerging markets, Wall Street managers would fall all over themselves offering to do it for very little money.

ETFs are cheap, but when you’re a big institutional investor, you can get plain-vanilla index exposure really cheap.


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