10 Strange But True Facts About The ETF Industry

by on October 31, 2011 | ETFs Mentioned:

As ETFs have burst on to the scene in recent years, just about every serious investor and professional money manager has taken a crash course in exchange-traded products, becoming familiar with the countless benefits and nuances of these products. Features such as enhanced transparency, upgraded tax efficiency, and low costs are generally well known at this point, as are the tickers of many of the more popular exchange-traded products [see also Bright Spots In The ETF Landscape: Five Funds Holding Their Value In A Wild 2011].

But even if you’re up to date on the latest developments in the ETF industry, odds are that there is quite a bit you don’t know about exchange-traded funds (and the various ETF cousins out there). Here are ten facts about the ETF industry that may seem a bit hard to believe:

1. Surprising Active ETF Leader

As of September 30, active ETF assets totaled about $5.2 billion–up sharply from only about $2.2 billion last year. While the adoption of active ETFs has not accelerated at the blistering page that many expected, expansion of this still-young corner of the market continues to churn along.

It shouldn’t be surprising that PIMCO’s MINT is the largest active ETF; the money market-like product from the bond fund giant has become popular as a cash alternative and general safe haven. What might be surprising, however, is that the largest issuer of active ETFs is not PIMCO or Columbia or AdvisorShares, but WisdomTree [see also Talking Actively-Managed ETFs With Tom Graves Of S&P].

With more than a dozen actively-managed ETFs–all of them currency or bond funds–WisdomTree accounts for well more than half of active ETF assets. The company may not hold on to that crown forever–the launch of an ETF version of PIMCO’s Total Return Bond Fund could tilt the scales immediately–but for now the firm known for its dividend-weighted products is also the active ETF king.

2. Largest Economy Without Dedicated ETF: Saudi Arabia

At this point, there is at least one ETF for just about every major world economy; dozens of country-specific equity funds cover everything from China to Ireland to Colombia. The largest economy (in terms of GDP) without an ETF is Saudi Arabia, which ranks as the 23rd largest economy in the world. Following Saudi Arabia on the list of major economies without a dedicated U.S.-listed ETF are Iran and Greece. According to the ETF Country Exposure Tool, the most significant Greece exposure comes from SEA.

France is the largest economy that is not covered by a dedicated small cap ETF. The U.S., China, Japan, and Germany are all covered by at least one small cap-focused ETF [see also Forget BRIC ETFs: Look To VISTA Nations For Better Opportunities].

3. iShares Is Quickly Losing Ground

At the end of the third quarter in 2009, iShares accounted for about 49% of the industry’s total assets under management. At the same point in 2010, that percentage had declined to about 46%, and the most recent monthly results show market share has slid further to only about 42%.

Much of that lost market share has come at the hands of Vanguard, the low cost ETF issuer has seen its share of total assets jump from about 11% to 16% over the last two years.

As part of a larger trend, there is evidence suggesting that investors are gravitating towards cheaper exchange-traded products. The correlation between expense ratio and YTD cash inflows is in the neighborhood of -0.10. That stat certainly isn’t perfect, but generally indicates that low cost ETFs are receiving greater cash inflows than more expensive alternatives.

4. ETFs Launched Before 2001 Account For A Third Of Assets

The ETF boom is generally thought of as a phenomenon that has played out over the last several years, as the number of products has multiplied and the asset base has surged. That is certainly the case, but the bulk of those inflows have gone towards products that are more than a decade old. The aforementioned $1 billion club is dominated by the “first generation” of ETFs that have an extended track record.

Investors and advisors tend to gravitate towards more established products with longer track records and larger bases of assets. But it’s important to keep in mind that an extended operating history or impressive base of assets is not necessarily indicative of the efficiency of a product or the validity of the investment thesis and index methodology. It often pays to look beyond the ultra-popular products with huge asset totals; smaller, newer products may offer more appealing exposure than the established, first-to-market funds that launched more than a decade ago.

5. Median AUM Of Ten Best Performing ETFs In 2011: $91 Million

To elaborate on the point made above, we compiled a list of the best performing ETFs from each ETFdb Category through the first nine months of 2011. While some of the category leaders are ultra-popular products–DBC, GDX, and XLU were each leading the way–for the most part the best performing funds are small, relative unknowns.

The median AUM for the group of ETFdb Category leaders as of September 30 was just $91 million. Excluding the three “super tickers” mentioned above, the average for this group is just $192 million. In other words, the relationship between size and fund performance is minimal; small funds are just as likely to deliver impressive returns as larger, more established funds [see also ETF Leaders: Best Performing ETFdb Portfolios of 2011].

Bigger is not always better; smaller products are certainly capable of delivering big gains. If anything, innovation in the industry has resulted in new products that address the flaws of earlier ETFs.

6. VOO: The Last Billion Dollar ETF?

Much has been made about the top-heavy nature of the ETF industry; while there are now close to 1,400 exchange-traded products, a select few account for the lion’s share of AUM. And creating a billion dollar ETF is becoming an increasingly difficult task as the lineup continues to grow; most new products are unlikely to ever reach that threshold [see also The Appeal Of Dividend ETFs].

There are currently about 140 ETPs that have more than $1 billion in assets, and the youngest product in that group is the Vanguard S&P 500 ETF (VOO), which debuted in September 2010. Other young members of the exclusive billion dollar club include the Alerian MLP ETF (AMLP, debuted August 2010) and WisdomTree’s Emerging Markets Local Debt Fund (ELD also launched in August 2010).

7. There’s No Short Euro ETF

After an impressive run of innovation in the ETF industry, it seems as if just about every corner of the market is covered by an exchange-traded product. With hyper-targeted sector ETFs rolling out regularly (more on this below) and country-specific funds covering nearly every corner of the globe, there are few segments of the investable universe that are not accessible through ETPs.

There are, however, a few notable omissions. For example, there’s no non-leveraged ETP to bet against the euro–a strategy that is likely in high demand in the current environment. There are a couple of products offering 2x leveraged short exposure to the currency (EUO and DRR) along with multiple options for betting on an appreciation in the currency [see also Euro Free Europe Portfolio Now Available].

UUP is the closest thing to an ETF that bets on a decline in the value of the euro; that fund is essentially long the U.S. dollar against a basket of developed market currencies that is dominated by the euro zone currency.

So there are still stones left to be overturned, and plenty of room for further expansion of the ETF lineup.

8. The Great ETN Boom Of 2011

In the 12 months ended September 30, ETF assets grew by about 7.9% to more than $958 billion. It’s interesting, however, that assets in exchange-traded notes (ETNs) are growing much more quickly; during the same period, ETN assets climbed by about 16%–nearly double the rate of growth for ETFs.

Perhaps the stellar growth turned in by ETNs shouldn’t be that surprising; in our minds, this structure has a number of potential advantages over traditional ETFs. Commodity ETNs, for example, offer several advantages relative to products structured as partnerships. Futures-based ETNs don’t mark to market annually, and won’t require investors to fill out a K-1 at the end of the year. Moreover, ETNs don’t incur transaction fees and brokerage expenses.

There are other asset classes where ETNs make sense as well; in certain environments, they may get the edge over comparable ETFs as a tool for establishing MLP exposure [see When ETNs Are Better Than ETFs].

9. Annual Revenues = $3.2 Billion

Perhaps the best piece of evidence indicating that ETFs have arrived is the staggering amount of money that the industry now generates–despite being built around the idea of bargain basement expense ratios. With an average expense ratio in the neighborhood of 50 basis points (the weighted average is even lower), ETFs are, on the whole, far cheaper than mutual funds. But there is still big money to be made in ETFs; annual revenues now exceed $3 billion [see also Micro Cap ETFs: Time To Think Small?].

The biggest earner in the ETF universe is GLD; the 0.40% expense ratio and asset base of nearly $65 billion translates into annual revenues of about $250 million. Other big earners include iShares’ EEM and EFA, which generate about $300 million between them. But those three are the only ETFs that generate at least $100 million in annual management fees (though VWO is close to cracking that level).

10. Niche ETFs Are Taking Off

Once upon a time, the ETF lineup consisted primarily of “plain vanilla” products linked to well known stock and bond indexes. In recent years, the pendulum has swung to the other end of the granularity spectrum; many of the new additions to the ETF universe are hyper-targeted in nature, focusing on narrow segments of the U.S. and international equity markets [see also Why The Fishing ETF Is Green Around The Gills].

There has been no shortage of scoffing at some of these ideas, with critics suggesting that quirky funds focusing on smartphones, fishing, fertilizers, and lithium would be enormous busts.

In reality, however, many of these hyper-targeted ETFs are being scooped up by investors and tactical traders looking to fine tune their portfolios. A handful of hyper-targeted funds have been rather successful, indicating that there is room in the ETF industry for both blunt and precise instruments. A few of the noteworthy early successes:

  • First Trust ISE Cloud Computing Index Fund (SKYY): About $57 million in AUM
  • Global X Fertilizers / Potash ETF (SOIL): About $33 million in AUM
  • Global X Lithium ETF (LIT): About $102 million in AUM

These funds aren’t threatening to join the $1 billion club, but their quick growth suggests that there is room for more targeted products in the ETF universe–even if that notion boils the blood of some ETF purists.

Disclosure: Photo courtesy of Daniel Schwen. Long ELD.