ETF take-up gathers pace but near-term challenges remain

We’re talking about the potential for the global ETF industry to go from its current size of around $3trn (£2.3trn) to more than $6trn in five years, and then $12trn in another five years. 

If those estimates sound naively optimistic, consider that in the past 20 years in aggregate, ETF assets have at least doubled in every single rolling five-year period.

If we think about the gap between the appearance of the first ETFs in the US in the early 1990s, and the subsequent start of the ETF market in Europe in the early 2000s, what’s interesting about the evolution of the growth in assets under management is that despite the near decade-long lag time, this growth is almost a mirror.

The drivers for this massive trend are well known, but a few factors with the potential to shape the nature of this quickly expanding segment in Europe, and the UK specifically, are worth keeping an eye on.

 The industry is now seeing a healthy proliferation of new products all designed to help investors build better portfolios

First, and perhaps most importantly, a rising tide of awareness and investor education about the ETF vehicle is fuelling industry-wide adoption. Structural challenges remain in Europe, but many members of the ETF ecosystem are working very hard to improve this infrastructure. 

ETFs are intrinsically efficient vehicles, and pending infrastructure improvements will further facilitate that. For example, investors are becoming increasingly tactical in terms of using ETFs to efficiently express their investment views. This is in addition to a growing population that are building the core of their portfolio with ETFs. 

As an industry we are also seeing creative uses of ETFs in areas such as cash equitisation, liquidity buffering, and as a compliment to existing active holdings.

Second, ETF flows will in part be driven by regulatory transformations across the continent such as Mifid II, which should encourage the use of ETFs with the ban on commissions for independent financial advisers. 

Similarly in the UK, the RDR may have enabled greater reach into the retail marketplace for ETFs than has been commonplace historically. 

Under Mifid II, ETFs could be more widely used for securities lending and collateral. As transparency and liquidity increases and improves, more and more institutional investors are predicted to become comfortable using the products.

A third catalyst to watch for ETF flows will be variety. Investors gaining confidence and comfort with the ETF wrapper and all the efficiencies that come with it are also exploring all of the variety of ETFs that are available.

It used to be that only plain vanilla cap-weighted indexes were used in ETFs. The industry is now seeing a healthy proliferation of new products all designed to help investors build better portfolios. 

Some in the industry would go so far as to say there are too many ETFs, but another view is that the variety is a huge benefit to investors as this enables them to build very tailored and unique portfolios. 

For example, tools from smart beta fixed income, to multi-factor strategic beta, to thematic and liquid alternatives are all allowing investors to build portfolios they never would have envisaged just five or 10 years ago.

In summary, the global ETF industry, and specifically the European ETF market, have a very bright future. Issues such as infrastructure and investor education are speed bumps rather than road blocks and they become more surmountable by the day. 

With the increasingly creative utilisation of ETFs as well as the sheer variety now available, momentum within the European ETF industry looks set to accelerate on its already rapid pace.

Bryon Lake is a managing director at JPMorgan Asset Management