2021 was yet another record year for the Exchange-Traded Funds industry in terms of asset levels and net flows. But what is next and can this incredible growth story continue? By Rob Rushe, senior ETF expert at CACEIS.
It is said that the first mutual fund was created in the early 1770s by a Dutch merchant, Adriaan Van Ketwich. He pooled the money from a number of individuals and created a diversified fund of bonds. Little did Adriaan know what he was starting and in the 250 years since, the industry has grown to well over €50 trillion in assets across the globe.
During those 250 years, it’s not just the assets levels that have increased. So too has the industry that developed to support it and the infrastructure that was needed to connect these investors to the world’s capital markets. Between the underlying investor and investment manager now stands an entire ecosystem of distributors, aggregators, fund supermarkets etc, and a myriad of complex processes, paperwork and legacy practices.
However, exchange-traded funds (ETFS) are changing all that. Since the first ETF was launched in the early 90s, the industry has grown to over $10 trillion now. So, why are ETFs so popular? Well, the easiest answer is probably that they were at the right place at the right time.
Weighed down by decades of legacy processes, vested interests and multiple layers of red tape, the mutual fund industry struggled to keep pace with the changing digital landscape of the late 1990s. It was an industry that was ripe for disruption or even a revolution! Then came the ETF. A product that removed all the intermediaries and brought the mutual fund directly to the door of the investor, through the use of the stock exchange. Gone was the need to go through a long change of counterparties and having to pay for the privilege. Also, gone was the need for all the paperwork or having to wait 24 hours for a dealing confirmation. You could now invest in a fund just as easily as it was to buy an equity. This, coincided with the technological revolution since the creation of the internet, has positioned ETFs as the perfect product at the perfect time.
When you ask someone to talk about ETFs, they will usually mention that they are index trackers, low-cost, transparent, tax-efficient, etc. This is mostly true of today’s ETF products, but that’s not the main driver of their growth. Especially going forward. The reality is they just simplify the investment process. In the modern world, where everyone has an app for everything, the ETF structure just works. If you have a broker app on your phone, you now have instant access to over 5,000 ETF funds. These funds will cover every asset class, country, sector, theme or strategy. Just one click for instant execution with no paperwork or delays. In fact, ETFs now form the building blocks for a large number of asset and wealth managers due to their simplicity.
So what’s next? While index tracking products have long been the focus of the ETF structure, it’s probably fair to say we are close to saturation point in terms of the number of different indices we can create to track. Also, it’s worth remembering that the ETF structure is not defined by the strategy, it’s the underlying technology, the ‘wrapper’, that can be used to deliver any liquid investment strategy. This brings us to the topic of active ETFs.
While the active ETF is not a new concept, it has always struggled to see the success of the passive products. This is probably due to the success of passive investing over the past 20 years, which has led to active managers seeing the ETF as a threat instead of an opportunity. They have focused on the more traditional features of an ETF (transparency, low fees, intra-day tradability) and thought there was no real driver to putting products in the ETF wrapper. However, this is changing.
In the US, thanks to the creation of the non-transparent active ETF, we are now starting to see a big shift to active products. The ETF structure also brings additional tax benefits over a traditional mutual fund in the US market, which is a big driver for this push. These products put aside the normal levels of transparency provided by ETFs and only disclose the portfolio to a select group of market makers, who can then provide on exchange liquidity for investors.
You could make the argument that the European ETF structure does not have the same tax advantages as in the US, so we will not see the same take-up of the active structure here. However, this would be a big mistake.
As we have seen, the success of the ETF is all about investor access. The market is fundamentally changing. Investors are not being drawn to the ETF market anymore, that’s now where they are. Not embracing the ETF structure is like a consumer goods retailer not selling their products online. They might survive if all their competitors do the same, but once one makes the move, they all have to or they face extinction.
It’s not too late
The good news is that it’s not too late. We are still only at the beginning of the active ETF journey. For those new to the ETF space, taking the first steps might seem like a daunting task. Indeed, there is a lot to consider. However, with the right guidance, it is not as difficult as it might seem.
At CACEIS, we believe the ETF industry will continue to be a key growth area for many years to come. As a result, we are continuing to put significant investment in our ETF servicing product offering.
In 2021 we successfully launched our innovative ETF dealing platform, TEEPI ETF. This is a state-of-the-art dealing portal with a tailored service for authorized participants to access the ETF primary market.
In addition, we have created a new dedicated business line to support our ETF clients and ensure that all aspects of the service delivery is tailored to the requirements of an ETF issuer.
We work very closely with new ETF issuers to ensure they understand not just what is done by CACEIS, but also how they might need to change to support an ETF product, and will provide the necessary introductions and guidance to all parties of the ETF ecosystem.
As one of the largest ETF service providers in Europe, CACEIS is very well positioned to provide clients with the benefit of 20+ years’ ETF experience and market-leading solutions to ensure clients are supported throughout their ETF journey.
Rob Rushe is senior expert – ETF solutions at CACEIS Ireland.
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