ETF growth screeching to halt, Lipper says

When exchange-traded funds arrived on the scene in 1993, many industry experts predicted that they would take the investing world by storm.

But while ETFs were strong out of the gate – since inception their assets have grown to more than $87 billion – such rapid growth is coming to an end, according to a report published earlier this month by Lipper Inc. in New York.

“ETFs have already been created to allow investment in most market and industry sectors, and many countries, so the launch of additional index-based ETFs covering those sectors will do little to accelerate asset growth,” the report says.

off the mark

As a result, the report states, some industry experts’ early predictions that ETFs would reach $500 billion by 2005 were “wildly high.”

That’s bad news for companies that have pinned their success on ETFs, such as Barclays Global Investors of San Francisco, a unit of Barclays PLC in London.

Of course, Barclays, the largest manager of ETFs, with $26.8 billion in its iShares complex, disagrees with much of the Lipper report’s conclusions.

James Parsons, managing director of sales at Barclays, agrees that new equity-oriented, index-based ETFs probably won’t do much to accelerate asset growth.

But what Lipper doesn’t take into account, he says, is the ability of companies such as Barclays to increase assets through marketing aimed at different distribution channels. It also doesn’t take into account fixed-income index ETFs, which the company hopes to release in the near future. They await approval by the Securities and Exchange Commission.

“I have a 42-person sales team on the street every day, and we’re seeing our growth continue,” Mr. Parsons says.

“We’re helping people understand how to use these products.”

For institutional investors, that means explaining the benefits ETFs have over other financial products, such as futures.

In many cases, ETFs are more liquid than futures, Mr. Parsons says. ETFs do not require any special documentation or accounts, and investors do not have to worry about roll costs and margin requirements.

Barclays announced last week that an institutional investor had made a $2.3 billion investment in one of its ETFs the previous week.

Explaining the benefits of ETFs to retail investors who are used to mutual funds is a little trickier, but it’s gotten easier in the current economic environment, Mr. Parsons says.

That’s because at a time when market volatility and the Enron Corp. debacle have given many investors the jitters, they are turning to financial advisers, he says.

Mr. Parsons says independent advisers in particular are open to ETFs because many already structure their clients’ portfolios around an index fund.

Getting them to replace that with an index-based ETF won’t happen overnight, but because ETFs are generally cheaper than index funds, it should happen eventually, he says.

tough assignment

The Lipper report doesn’t deny that ETFs have benefits over other investments but suggests that even with a successful marketing effort highlighting such benefits, it would be hard to continue the pace of growth ETFs have set for themselves over the past few years.

ETFs have attracted the initial wave of cash that the excitement of a new product brings, and without any new twists to the index-based ETF model, they are unlikely to experience the “extreme” asset growth that got them to $87 billion in less then 10 years, the report says.

While Barclays maintains that there is investor demand for a fixed-income product, Lipper in its report states that it doubts such ETFs will be hugely successful, because retail investors are not very interested in the bond sector.

And because virtually all equity indexes are covered by ETFs, unless the SEC gives actively managed ETFs the green light – which probably won’t happen anytime soon – it doesn’t look like there will be many new products in the near future.