The exchange traded funds (ETF) industry could surpass the hedge fund industry in assets under management (AUM) in the next 12-18 months, according to EY’s global ETF survey.
While growth rates will be highest in Asia and lowest in the more mature US market, the growth drivers will be the same across all markets – foreign currency share classes, fund of fund ETFs, new emerging market funds and commodity ETFs.
Lisa Kealy, ETF leader in Europe, the Middle East, India and Africa, EY, said: "Growth will come from innovation, from more wide-spread users of, and uses for, ETFs as they take market share from active and other passive competitors. But this year there is a growing awareness amongst promoters that this innovation leaves them open to increased risk – that "someone else’s mistake" could undermine the industry in the eyes of regulators and consumers and damage the whole industry’s growth prospects."
The EY Global ETF Survey interviewed more than 60 promoters, market makers, investors and service providers over 13 markets, including promoters representing 87% of the industry’s global assets. The interviews were conducted during October and November 2013.
Asia-Pacific market to grow 20-30% annually, whereas the US will grow by 15%
The US market is relatively mature, with 70% of the global ETF assets, but it is still set to grow at 15% annually. Growth rates in Europe will average 15-20% while those in Asia Pacific amongst the highest in the world at 20-30% per annum.
Lisa said: "The European market is comparatively sophisticated, but geographically fragmented and carries a heavy regulatory burden. The rapid development of Asian ETF markets suggests that they could leapfrog ahead of Europe in the future."
Matt Forstenhauseler, Global Asset Management ETF leader, EY, said: "The US market is still growing at 15%, which is an incredible rate for a more mature market. A significant proportion of US inflows represent inward investment from other regions, including Asia and Europe, suggesting that the domestic market may have reached maturity."
Expectations of retail growth more upbeat across all markets
US respondents see more innovative products such as active funds, commodity funds, enhanced beta and termination date products as key areas for growth. In contrast, Europe and Asia expect growth to be focused on fixed income products and they have very low expectations for growth in termination date products.
Expectations of retail growth have become more upbeat across the globe this year, with 49% of respondents expecting retail investors to drive strong growth, compared to just 20% last year. Asian respondents in particular see strong potential for retail take up of ETFs (57%).
However, this year the industry also seems increasingly aware of how vulnerable it could be to the negative effects of a scandal, especially in the retail market. Those surveyed think that regulators should be focusing their attention on leveraged ETFs and ETFs not covered by European Securities and Markets Authority and Undertakings for Collective Investment in Transferable Securities (UCITS).
Despite the recent regulatory focus on synthetic or swap-based UCITS ETFs, the majority of the industry (75%) believes that there is a future for swap-based products.
US$100m seen by more than a third of the market as the minimum size for success
Achieving scale remains the leading barrier to entry and is a greater challenge in 2014 than it has been in previous years. In addition, lack of liquidity is the most frequent reason that fund launches fail. More than 90% of those surveyed view US$50m as the minimum size for an ETF to be viable. More than a third of respondents said US$100m was the minimum size.
Lisa said: "The importance of liquidity and its close link with scale continues to act in a self-reinforcing way and as a result new entrants are finding it increasingly difficult to compete directly with the industry’s largest players. A breakthrough in centralized settlement and improving liquidity in Europe will be the key to untapping significant latent growth."
Eighty-percent of those surveyed said they expected the top three’s market share to remain stable and a further 15% expect it to grow.
Fees under pressure but expectations for consolidation have fallen
The number of respondents expecting a decrease in management fees (49%) far outweighs those predicting an improvement (9%), but nearly half of respondents expect fees to remain static.
Lisa added: "It is no surprise that respondents see the outlook for management fees as veering towards the downside but this fall in margin will not be significant enough to drive a wave of consolidation. Instead, promoters are focusing on launching fewer and more innovative products, which they hope will have higher success rate and maintain margins."
While expectations of mergers and joint ventures are marginally up, expectations of acquisitions of smaller promoters by larger players are significantly down on last year, and the market expects to see more promoters exit the market of their own accord.