There are numerous compelling reasons to invest in an ETF, and just as many to launch one. For both investors and product providers, the ETF industry has demonstrated strong and continuous growth over the years – and growth is always attractive.
Since the first U.S.-listed ETF debuted in 1993, the number of products, ETF asset creations, and total assets (creation plus market performance) have shown a consistent upward trend, indicating further expansion in the long term.
Even amid turbulent markets, high inflation, and aggressive Federal Reserve policies that have affected all asset classes, the ETF market has shown remarkable resilience. As of April 2024, there are over 3,191 ETFs listed on U.S. exchanges, managing more than $8.8 trillion in total assets.
What’s driving the success of ETFs? It’s largely due to the numerous benefits the ETF structure offers both clients/investors and product providers.
Client Alignment Growth Factors
As an investor, the appeal of ETFs lies in the distinctive advantages inherent to their structure. Here are the key drivers of ETF adoption compared to other commingled funds:
- Portfolio Transparency: ETFs typically disclose their holdings daily, with this information readily accessible on issuer websites and various other platforms.
- Lower Costs: ETF fees are often significantly lower than those of other investment products like mutual funds. The cost efficiency is so pronounced that the market has even introduced a few zero-fee ETFs.
- Liquidity: ETFs offer intraday trading in both primary and secondary markets, making them real-time price discovery mechanisms that investors can easily access and trade, regardless of the underlying asset.
- Tax Efficiency: The unique in-kind creation/redemption process of ETFs allows for better tax management, minimizing the likelihood of capital gains distributions by offsetting low-cost basis securities over time.
These benefits make ETFs an attractive option for a wide range of investors, from large institutions and asset managers to individual retail investors.
Industry Growth Factors
As an industry, there are many benefits to being an ETF provider as well.
Beyond the consistently strong investor demand for ETFs – everyone wants to create a product that clients are clamoring for – there are real benefits to the business of being a provider.
- Operational Efficiency: streamline your business and outsource the detailsETFs provide a streamlined way for you to package your expertise into a single ticker symbol. For example, if you’re a Registered Investment Advisor (RIA), you can create an ETF to deliver your investment expertise to clients across your entire book. Managing multiple separately managed accounts (SMAs) is time-intensive and not scalable.
By using an ETF instead of multiple SMAs, you can outsource back-office operations, portfolio management, and trading. All the day-to-day tasks of running an ETF can be handled by tech solutions and industry participants like operators, custodians, and traders.
Client conversations also become simpler. Communicating results and managing investment expectations is challenging at the single account level. However, with an ETF, the transparency allows for straightforward, portfolio-based discussions and assessments. Compliance and trade execution management are also easier with a single ETF.
For asset managers running mutual funds, the path to ETFs is now smoother with the adoption of Rule 6c-11, the “ETF Rule,” which facilitates conversions. You can convert your mutual fund strategy into an ETF while preserving the existing investment objective, track record, performance history, and board of directors. Plus, the conversion should not be a taxable event.
- Access New Audiences: Expand your reach and distribution channelsETFs are listed as stocks in exchanges across the country and available across multiple platforms. By design, ETFs reach anyone interested in what they offer, whether that investor is in your client book or whether they find that ticker through a brokerage account.
That means ETFs can expand your existing reach, whether you are an RIA, an asset manager, a hedge fund manager, a family office, or even an entrepreneur.
If you run a mutual fund, by launching an ETF of your strategy you may find a whole new following among investors who are looking for intraday trading.
If you run a hedge fund, for example, you typically transact among high net worth accredited investors, but an ETF can broaden that reach into the advisor, retail, intermediary and potentially institutional spaces because ETFs are typically lower cost, liquid, easy to access and trade through brokerage accounts.
If you are an entrepreneur who is an expert in a certain field, through an ETF you can make that expertise or that theme investable. The ETF makes your expertise now easily accessible to anyone.
By launching an ETF you can not only reach a massive audience across retail, advisor, intermediary and institutional channels, but you can also broaden your reach in the form of product line completion. By expanding your offering, you are expanding your access to new segments, and possibly relying on ETFs as the gateway strategy to an upsell opportunity down the line.
- Branding: Make your expertise knownThe ETF market includes major global financial services firms. By launching ETFs, you are putting your business in the same turf as JP Morgan, Blackrock and Vanguard among many others.
As of November 2022, there were 270 different ETF providers in the U.S. offering more than 3,070 ETFs. The industry has welcomed 50 new providers in the past 12 months and launched roughly 3 ETFs to each one it closes, according to our data. Competition is definitely steep.
But so is the opportunity to bring to market unique expertise or a new idea packaged in an ETF. By launching an ETF, you can make that expertise or idea investable and accessible, tying your brand to a memorable ticker that’s available to investors in and beyond your existing client book.
The broad, democratizing reach of the ETF market means your brand and your expertise can be at everyone’s fingertips, competing for the same investor dollars whether you are a JP Morgan or a small brand-new firm.
- Tax Efficiency: Better tax management for your clients
The creation/redemption mechanism unique to ETFs allows the funds to be far more tax efficient than mutual funds and other investment products.
Any given year, according to various data providers, less than 10% – and often less than 5% – of all ETFs issue capital gains distributions. That’s because ETFs can rely on Authorized Participants to be thoughtful when creating/redeeming ETF shares and unload low-cost basis securities through custom baskets throughout the year, effectively washing out capital gains overtime, making distributions a rare occurrence.
SMAs, for that same benefit, require a lot of optimizations. Mutual funds and hedge funds can’t do that at all.
Clients invested in ETFs only pay taxes when they exit the fund. They don’t face a tax event associated with actions from other shareholders, as they may in mutual funds. If you are the product provider offering mutual funds, consider that through an ETF your clients should not be faced with a surprise tax bills on gains tied to another investor’s sale of a position – that’s a real benefit. As a hedge fund manager, ETFs can allow you to offer a more tax efficient version of your hedge fund strategy.
Taxes matter, and when it comes to offering investors and clients tax efficiency, ETFs do it best compared to other commingled fund structures.
ETFs for Better Outcomes
Investing in ETFs comes with unique challenges for both investors and product providers. While ETFs are praised for democratizing market access, they can only be purchased through a brokerage account, not directly from the provider. This requirement, unlike mutual funds and hedge funds, presents a distinct challenge in terms of accessibility.
For providers, distribution is a significant hurdle that must be overcome to fully realize the reach potential of ETFs. Additionally, the transparency of ETF portfolios, often considered a key advantage, can sometimes be a drawback. For instance, managers aiming to capitalize on market inefficiencies may find it harder to capture alpha, and Family Offices might view extensive disclosure as a reputational risk.
Despite these challenges, the advantages of owning and launching ETFs are numerous. This is evident in the continued growth of the ETF market, with an increasing number of funds, participants, and assets. Whether you’re a newcomer or have an established strategy, ETFs are becoming the go-to solution for various market access objectives.
If you have a brilliant new idea or a fresh perspective on a market segment or theme, consider launching an ETF.
