15 transformational events: ETFs rise in race for assets

For a little perspective on the exchange-traded-fund phenomenon, consider this: Open-end mutual funds took 66 years to amass $1 trillion in assets.
ETFs, which burst on the U.S. investment scene in 1993, blew past that threshold in just 17 years. Sure, with $1.4 trillion in total assets, the ETF industry remains tiny compared with the $13 trillion mutual fund industry.
Over the years, however, the ETF world has proved to be a hotbed of innovation that has captured the hearts and imagination of financial advisers. From the iShares SPDR S&P 500 ETF (SPY) to a market now represented by more than 1,200 products, the ETF industry has grown alongside and with the support of the financial advice industry.
“Financial advisers have absolutely embraced ETFs,” said Benjamin Johnson, director of passive research at Morningstar Inc.
“The growing popularity of the fee-based model is clearly driving more advisers to ETFs,” said John Spence, web editor at Global Trends Investments, a site launched in 2006 to help educate investors about ETFs.
Although it is true that a majority of the assets still are concentrated among a few funds at a handful of providers, the ETF marketplace has become nothing if not eclectic and opportunistic.
Consider, for example, the WisdomTree Japan Hedged Equity ETF (DXJ), which gives investors access to the white-hot Japanese equity market while hedging out the currency risk. The $5.6 billion ETF, which WisdomTree Investments Inc. launched in 2006, led the ETF industry with $4 billion in net inflows during the first quarter of this year.

PHOTO GALLERY 15 transformational events

Indeed, the ETF evolution has moved well beyond plain-vanilla equity indexes to include fixed-income, active-management and alternative strategies, as well as just about every global and niche market imaginable.
For advisers, this has created more opportunities to customize the asset allocation process but also added a new level of focus on low fees and transparency.
“The more transparent the cost of advice, the greater the incentive there is for the adviser to reduce costs,” Mr. Johnson said. “Cost is clearly a factor.”
ETF fees vary depending on the complexity of the strategy, but in most cases, they hold a cost advantage over comparable mutual funds. For example, the net expense ratio of the SPDR S&P 500 ETF is 9 basis points, which compares with 17 basis points for the Vanguard 500 Index (VFINX) mutual fund.
Of course, fees are only part of the appeal. What attracts advisers most is the way that ETFs trade throughout the day like stocks, as opposed to once daily like mutual funds.
“You are absolutely going to get a lower expense ratio with an ETF, but there is also a huge liquidity advantage,” said Josh Pierce, director of research at Baystate Wealth Management.
The firm, which is just three and a half years old, has 90% of it $350 million under advisement allocated to ETFs. That is something that wouldn’t have been possible a decade ago, let along conceivable.
“At this point, by the time clients come to us they’ve heard and understand the ETF story,” Mr. Pierce said.
Like a lot of ETF proponents, Baystate isn’t doing anything remotely resembling day trading.
But the ability to trade throughout the day, if necessary, can introduce a new level of comfort, Mr. Pierce said.
“We saw during the financial crisis in 2008 that the worst time to be holding some positions was right before the market closed because nobody wanted to buy anything,” he said. “With a mutual fund, they all trade at 4 p.m., but with an ETF, at least you can put in stop-loss orders to minimize the downside.”
Even considering the popularity and pace of growth in the ETF market, most analysts think that we are still in the early days of the industry, which will continue to innovate.
As Mr. Johnson pointed out, 75% of the ETF industry assets are concentrated in funds launched prior to 2007.
“That means most of the money is still in plain-vanilla or plain-beta strategies,” he said.
In essence, the market has grown to this point largely due to lower fees and better liquidity.
One can only imagine how fast will the industry take off once ETFs become regular retirement plan offerings, and as more advisers go the way of firms such as Baystate.