Celent and Moody’s Predict Further ETF Growth By Chris Flood

The exchange traded funds industry is poised for further growth in 2012 and beyond, according to a pair of reports published this week by Celent, the research consultancy, and Moody’s Investors Services, the ratings agency.

New rules and regulations should be a net positive for the ETF industry, according to Moody’s ETF Industry Overview report, which said that the harmonisation of product labelling and increased disclosure and reporting was a “necessary and logical next step”.

Global ETF assets to exceed $3.8tn by 2016

Joanne Job, an analyst at Moody’s, said that clear and harmonised definitions for all exchange traded products, including notes and commodities as well as funds, would both improve transparency and help educate investors about potential risks which should in turn help improve confidence in the industry.

But Moody’s also cautioned that greater regulatory scrutiny could also reduce profit margins for ETF providers by increasing their operating costs.

Ms Job said that any increase in costs as a result of regulatory changes would encourage providers to look at revenue maximisation strategies such as securities lending. Any regulatory changes that curtailed ETF providers’ ability to generate additional revenues could put pressure on smaller managers to merge with larger players to preserve margins.

Looking ahead, Moody’s painted a mixed picture for growth in Europe, cautioning that the sovereign debt crisis and ongoing debate over synthetic ETF regulation was likely to hinder growth. But new regulations such as the UK’s Retail Distribution Review and the EU’s Mifid II directive, should lead to a wider acceptance of ETFs among retail investors.

In the US, Moody’s said it expected to see a rush of active ETF launches this year if regulators lifted current restrictions as this change could attract more big-name asset managers into the industry.

In Celent’s “Exchange traded funds: growth and challenges” report, the research consultancy predicted that global ETF assets could between $2.5tn and $4.5tn by 2017, from around $1.525tn at the end of 2011.

But Anshuman Jaswal, senior analyst for Celent, also noted success is becoming harder to achieve for new products in an industry which is becoming more mature.

Almost four-fifths (79 per cent) of the new products launched in the first half of 2011 failed to attract $30m in assets.

Noting that more than half of the ETFs listed in the US have assets of less than $100m, Mr Jaswal said the failure of a large number of products to reach a profitable scale was expected to drive further rationalisation in the industry.

Looking at the active ETF market, Celent suggested that if these products did take off, then they could capture a quarter of the entire US actively managed investment market by 2020. But under a pessimistic scenario, active ETFs would only grow to 5 per cent.

Active ETFs currently have assets of about $7bn but remain a tiny part (less than 1 per cent) of the total US ETF market.

Celent said that an important catalyst for active ETF growth would be the development of a practical method for converting existing mutual funds into ETFs.

“This could enable an asset manager looking to expand into the ETF space to maintain performance track records and achieve large size at launch,” said Mr Jaswal.

Recent ETF launches by high profile active managers (such as Bill Gross of Pimco) would be seen as an endorsement of these products and should help accelerate their adoption, said Mr Jaswal.