Key Drivers Fueling Strong ETF Growth

BlackRock has a new prediction: Global ETF assets could grow to $12 trillion in five years, $25 trillion in nine.

The forecast isn’t as bold as it is consistent. Today the ETF market commands about $5 trillion in assets globally, and ETF assets have been growing at an average annual rate of about 20% since the financial crisis.

Assuming the rate of growth stays pretty much the same, that would put total ETF assets at around $12 trillion globally by the end of 2022. BlackRock’s forecast essentially says ETFs should continue to march on in the same steady pace of expansion they’ve been on since 2009.

It’s steady as you go as far as BlackRock sees it, understanding the power that compounding has on total assets.

What’s interesting about this forecast released in a report this week is what BlackRock sees as the factors driving the growth rate going forward. The asset manager behind iShares—the largest U.S. ETF provider—says four key trends that have accelerated in the past year will push ETF assets further up.

ETF Investors Are ‘Active’

ETFs are used more and more for specific outcomes than for simply owning the broad market, according to the BlackRock research paper released Wednesday. ETF investors are making active decisions when building portfolios, and it’s that active use of ETFs as portfolio tools that’s going to help grow adoption.

“When you look at the choices investors are making in the risk/return profile of portfolios—picking international versus domestic, value versus growth, single-country funds—asset flows are diverse, and show that the lion’s share of ETF investors’ money is going to overweights and underweights [active tilts] relative to a single-market portfolio,” said Martin Small, head of iShares at BlackRock.

According to BlackRock, the old focus on individual security selection is being increasingly replaced by a focus on asset allocation, and ETFs are great building blocks for that.

Investors Sensitive To Cost

Investors are extremely cost aware, especially in the past decade since the financial crisis. Low cost wins for core broad asset allocation purposes, and ETFs are typically very low cost. It’s no surprise that demand for low-cost investment vehicles will continue to fuel ETF asset growth going forward.

BlackRock says investors paid lower fund fees in 2017 “than ever before.” Average index fund costs have dropped more than 35% in five years to an average 0.18%. Active funds have seen average fees drop to 0.77% versus 0.86% five years prior.

Financial Advice Changing

Increasingly, financial advisors are paid based on asset-based fee models rather than commissions. That benefits ETFs, because the move toward fee-based models is pushing advisors toward lower-cost investment vehicles such as ETFs. Assets in U.S. fee-based accounts have quadrupled since 2005, and some say could double again by 2020, according to BlackRock.

“2017 was a real tipping point for growth of fee-based advice in the U.S.,” Small said. “It was a big year for model portfolios and asset allocation strategies, setting a new trendline for how we’ll see that part of our market wealth grow.

“Last year, almost 80% of our flows came from retail and asset allocation portfolios in the land of financial advisors, which is unusually high,” he noted. “The predominant model in the U.S. for financial advice through 2014 was brokerage commissions. You paid your financial advisor through products. In 2014, only about 30% of U.S. investors had some kind of relationship for financial advice that wasn’t based on commissions. Today nearly half of people who have money in the market have fee-based advice.”

Fee-based advice is the model that’s growing fastest, and when investors move to fee-based, they end up using an asset allocation model that relies on ETFs.

Bond ETFs Offer Efficient Market Access

Bond liquidity that institutions have come to depend on has “evaporated,” the report says. ETFs can help investors overcome the liquidity as well as the access issue.

“Bonds don’t trade on exchanges like stocks. In many ways, bonds are like buying life insurance. You have to get a quotation from somebody, the market is less transparent, it’s hard to comparison shop, it requires several calls,” Small said. “The bond market is less efficient, more cumbersome. Most investors who haven’t built big-scale bond trading platforms don’t have a great way to access this market other than the bond ETF.”

“For many clients, not buying managed bond products is irresponsible. ETFs level the playing field for everyone in bonds,” he added.

Assets in bond ETFs are growing at a faster annual pace than equity ETFs both here and in Europe.

Conclusion

What could derail this impressive growth pace the ETF market has enjoyed for several years?

“The direction of travel is permanent, Small noted. “The velocity with which these milestones will be reached are best estimates based on current growth rates.”

“But if you saw a significant pullback in markets when people take money out of the market, these changes would happen a little slower,” he explained. “That’s not a risk to the ultimate projection; it just means the timing would be a little bit different or a bit delayed.”

Contact Cinthia Murphy at [email protected]