With Big Three dominating, smaller ETF players folding

The ETF Big Three's stranglehold on the industry is finally starting to make some smaller players tap out and could lead to more mergers and acquisitions.

The dominance of BlackRock Inc.'s iShares, State Street Global Advisors and The Vanguard Group Inc. when it comes to exchange-traded funds is nothing new. Combined, the three firms hold $1 trillion of the $1.2 trillion of assets in all ETFs.

And they show no signs of slowing down.

Those three firms received $70 billion of the $96 billion, or nearly three of every $4, invested in ETFs through the end of last month, according to Morningstar Inc. That put them on pace for their best year since at least 2009.

Last year, the three took in a combined 66% of net inflows, and in 2010, they had 71% of the inflows.

“The larger ones out there had the first-mover advantage,” said Mike Rawson, an ETF analyst at Morningstar. “Now they have the assets and the trading volume.”

James DePorre, president of Shark Asset Management Inc., said that there is little reason to look beyond the Big Three, because trading volume is what he relies on.

“If ETFs were more efficiently priced, I'd be more interested in the thinner vehicles,” he said. “But because of the disconnect with the underlying assets, there is little choice but to stick with the more liquid and heavily traded ETFs.”

The reluctance of financial advisers to look at smaller ETFs is making it harder for smaller providers to compete.

Last week, Scottrade Inc. and Russell Investments both said that they are pulling back from the ETF industry as a result of a lack of investor interest. The two firms have about $100 million in ETF assets each.

“GOOD BRAND NAMES’

Scottrade will be liquidating its entire lineup of FocusShares ETFs this month.

Russell is conducting a strategic review of its ETF lineup, which will result in about 30 layoffs, according to a report by Bloomberg News.

“Both firms had good brand names and some distribution experience,” Mr. Rawson said.

“It's sort of disappointing that they both only gave it a little over a year,” he said. “I don't think that was enough time.”

Garrett Stevens, chief executive of Exchange Traded Concepts LLC, an ETF advisory firm, said that there just isn't room to compete when it comes to broad, vanilla ETFs.

“Growth is going to come from niche products at this point,” he said.

Those products take time to catch on, though, Mr. Rawson said.

The Russell ETFs, for example, are primarily quantitative strategies that seek to outperform.

“It wasn't proven they were going to work,” Mr. Rawson said.

“It's almost like with active management,” he said. “You need a three-year track record.”

Smaller firms generally don't have that kind of time to wait. As a result, Mr. Rawson and Mr. Stevens anticipate that there will be more mergers and acquisitions between ETF firms and traditional asset managers.

Acquisitions could be a way for traditional asset management firms to sidestep the crowded registration process at the Securities and Exchange Commission. It can sometimes take a year or more to get the green light from the SEC to launch ETFs.

[email protected] Twitter: @jasonkephart

Related Topics: State Street Global Advisors