Two-thirds (67%) of respondents interviewed for the EY report  Global ETF Research 2017: reshaping around the investor believe most managers will have an ETF offering in the next five years. The new entrants will join a market that is expected to reach US$7.6t globally by the end of 2020.

Based on interviews with ETF market makers, service providers and promoters who collectively manage 85% of global ETF assets, the report suggests that ETF providers will face new challenges as the industry grows in size and influence. 

Lisa Kealy, EY EMEIA Wealth & Asset Management ETF Leader, says:

“ETFs can no longer just be cheaper or more liquid than actively managed mutual funds. The industry will need to innovate around investors, refine investor journeys and reduce investor costs to remain competitive.”

How investors use ETFs

The ETF market will be transformed by both current and new investors. The research suggests that 15% to 25% of ETF inflows over the next three years will come from new investors – an inflow of US$250b. Investors typically first turn to ETFs for selected exposures they cannot access elsewhere, but then become more comfortable using them as the building blocks of portfolio construction.

Institutional investors will continue to dominate ETF investing over the next three years, according to 97% of interviewees. The report highlights wealth managers, private banks and investment funds as promising areas for growth. It also states that pension funds are expected to use ETFs for liquidity management while wealth managers are expected to look for core exposure through model portfolios. Certain hedge funds will use leveraged and inverse ETFs to execute high-conviction long or short positions.

Julie Kerr, EY Asia-Pacific Wealth & Asset Management ETF Leader, says:

"The ETF industry needs to do more to help refine investor journeys for institutions by understanding and anticipating the long-term needs of different investment groups, addressing their concerns and developing the expertise needed to meet their unique challenges.”

Innovating in a complex market

The research shows that 2.9% of inflows now go to funds with assets under management (AUM) below US$100m. Fifty-five percent of respondents said they did not believe the success ratio of new launches will improve in the future. According to the report, ETF providers will need to anticipate investor needs, incorporate macro trends in regulation and technology, and focus on educating investors. Product development will take many forms, including new thematic ETFs, greater access to debt and investing in alternatives.

ETF offerings will help new entrants defend against declining mutual fund inflows. For many of them, ETFs will only form a part of their product range and will focus on emerging areas such as fixed income or smart beta. 

Falling fees and new competition

ETF fees continue to fall, reaching on average 27 basis points last year according to the research. While the report contends that “zero-fee” ETFs will not become the norm, 71% of people interviewed expect fees to fall further as becoming a low-cost provider becomes a prerequisite to survival. Assets in passive funds will exceed assets in active funds globally in 10 years and ETFs will benefit disproportionately from this shift because of their low fees and intraday liquidity in volatile markets.

Beyond top-line fees, firms are future-proofing operating models by looking to reduce all costs of ownership. Forty-three percent of respondents feel there is insufficient competition between index providers and expect more players to enter the space, including more self-indexing. Participating in stock lending programs, digital distribution and best execution are other ways to continue to bring down costs for investors.

Guiding investors through regulation

Sixty-one percent of people interviewed for the report expect regulation to change the way ETFs are distributed. ETFs should, in aggregate, benefit from regulatory changes, such as the Department of Labor Fiduciary Rule and MiFID II, as these changes should lead to greater transparency. But as the regulatory landscape continues to grow, there is additional scrutiny of the industry’s systemic risk and taxation.

Matt Forstenhausler, EY Global and Americas Wealth & Asset Management ETF Leader, says:

“The industry needs to address market and regulatory threats and be willing to respond by developing new products and modifying existing products. A combination of local understanding and global insights can help investors understand the overall business environment and how this will impact investor journeys.”