How the ETF market is both growing and shrinking

Fund launches have slowed a bit, while closures are on track for a record year.

  • By Ryan Vlastelica,
  • MarketWatch
  • Investing in ETFs
  • Exchange-Traded Funds
  • Investing in ETFs
  • Exchange-Traded Funds
  • Investing in ETFs
  • Exchange-Traded Funds
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Exchange-traded funds are perhaps the hottest thing on Wall Street, but the massive growth they're seeing isn't as widespread as you might think. In fact, one of the records they're set to break this year suggests they may be getting too big in some respects.

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That ETFs have seen blistering growth over the past decade is by now old news. U.S. listed ETFs have nearly $3.2 trillion in assets, up from $498 billion in 2009, according to research firm ETFGI. (Globally there is $4.4 trillion in ETF assets, up from $716 billion in 2009.) This growth has occurred alongside an explosion in new funds. Currently, there are 1,779 U.S. listed ETFs, along with another 270 exchange-traded notes, up from just over 700 in 2008.

Fund launches have become an almost daily occurrence on Wall Street, with 241 ETPs coming to market thus far this year. (ETPs, or exchange-traded products, include both ETFs and the much smaller category of ETNs.) In November, 38 funds were launched by the middle of month, including a big suite of single-country funds from Franklin Templeton.

One of the latest funds to hit exchanges is the ProShares Decline of the Retail Store ETF (EMTY), an inverse fund that essentially bets that brick-and-mortar retail stores will continue to struggle.

While the number of funds has been rising, so has the number of fund closures, as seen in the following chart, derived from Morningstar Direct data. As Ben Johnson, Morningstar's director of global ETF research noted, ETFs are "on pace for [a] record number of closures."

A liquidation isn't like a company going bankrupt, in that a fund closing isn't a reflection on its performance. For the most part, sponsors close funds because they haven't amassed enough in assets to be profitable.

Lee Kranefuss, one of the founders of industry giant iShares, recently said that "there are too many funds," and predicted the number of fund launches would slow over time. "More people will realize they can't write a hit song," he wrote, adding that he expects fewer funds in the future, meaning closures could outpace new funds, a trend that has already been seen in the hedge fund industry.

Earlier this year, in what was viewed as a Hail Mary attempt to avoid closure, a fund tracking real estate in Latin American took the unusual step of changing its investment objective so that it will instead hold companies in the cannabis industry.

Sam Masucci, chief executive officer of ETF Managers Group, the sponsor of the changing fund, explained the switch to MarketWatch. "Being an adviser and ETF issuer we have a need to make sure a fund resonates strongly with investors and that it's solving a portfolio allocation problem. [The fund] was a strategic product that was a first to market and saw strong performance, but for whatever reason the performance wasn't reflected by the growth in investor interest."

The difficulty for fund sponsors is that while the ETF industry is seeing massive growth, that growth is incredibly concentrated within a few major funds, sponsored by a few major companies. The 15 largest funds together account for more than $1.1 trillion in assets, or more than a quarter of total global assets. The "big three" providers — BlackRock's iShares, Vanguard, and State Street Global Advisors' SPDR family — together amount to nearly 70% of the market, and they have been seeing the bulk of inflows.

Fees have gotten so low in the major product categories that investors are looking beyond that metric in selecting their funds; Vanguard recently launched a new fund and urged investors to "consider elements beyond the expense ratio, such as investment strategy, methodology, tracking difference, spreads, tax efficiency, and brand."

"A lot of white space has long since washed away," said Morningstar's Johnson, referring to how major market categories are already represented by large funds that offer rock-bottom fees and heavy liquidity.

"The big firms came to the beach and put their towels down decades ago; now, everyone is fighting over the small patch of sand that's next to the trash can next to the off-ramp of the beach. The big hurdle facing small providers is big providers. Most don't have the name recognition, the distribution capabilities, nor the ability to price competitively."

A number of new or upcoming funds go beyond the kind of core portfolio holdings that most advisers say are appropriate for the average investor. One proposed fund only holds companies that donate to Republican Party candidates, another is focused on shares of companies determined to be supportive of veterans. One fund sponsor filed for an ETF related to blockchain; a different firm did the same later that day. The ProSports Sponsors ETF (FANZ) only holds companies that partner with one of the four major U.S. sports leagues.

Perhaps inevitably, an ETF that tracks the ETF industry was launched in April.

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