Stepping Into the ETF Business? Think Twice

“I am thinking of launching an ETF business. I would like to believe that investors can benefit from a more differentiated product. $ to $1 billion AUM can be earned I want to pick your brain.

This is how a would-be ETF issuer recently introduced himself to me on LinkedIn.

“Think about it,” I advised.

The rapid growth of the ETF industry attracts entrepreneurs who dream of capturing a share of the ETF market. After all, 146 of his ETF issuers have attracted some of his $604 billion in 2022 ETF inflows. How hard would that be?

The ETF industry is highly competitive and saturated, which makes it very difficult. With each new entrant, the number of products increases and so does the noise. Data-rich assessments of opportunities, obstacles, and industry trends can help LinkedIn personnel make informed decisions.

ETF Growth Explosion

Opportunities are easy to measure. The ETF has seen phenomenal growth in the US, with annual organic growth of 12.25% for the last five years he. 2022 was the second-largest ETF flow ever, despite a market plunge.

Source: Factset

The number of ETFs has also increased steadily, growing at about 8% annually over the past five years. The ETF industry is a very bright spot, especially compared to mutual funds.

The tilted ETF landscape

Certainly the LinkedIn guys have seen growth. He probably also understood that while his $6.5 trillion (as of Dec. 31) in his ETFs in the US is unevenly distributed, there is room for smaller companies to grow. prize.

It is dominated by the largest asset managers. Blackrock, Vanguard and State Street (the “Big 3”) control 77% of the market. The next 10 companies control 17.5% of him, with 219 small businesses competing for the remaining 5.5%.

Here is a chart of US ETF market share by issuer as of December 31, 2022.

Source: Factset

But the ETF market is not static. In 2022, the Big 3 got his 65% of the flow and 219 got his 11% (not including mutual fund conversions). In other words, small businesses have doubled the flow share compared to the original market size.

Chances are real. But that doesn’t mean it’s easy to get into the ETF business. Especially in the last few years, dozens of companies have decided to go where the money is. As the chart below shows, competition is intensifying.

Source: Factset

The recent rise in new ETF managers has not correlated so much with explosive ETF asset growth as it has due to regulatory changes. The SEC said he opened the floodgates in late 2019 as “ETF rules” reduced barriers to entry. Soon after, the approval of opaque actively managed ETFs gave asset managers confidence that their intellectual property could be protected, and the asset manager began turning mutual funds into his ETFs. .

Hence the explosion of ETF companies. Guys on LinkedIn will face a lot of competition.

captive assets

Competition limits opportunities. As a result, newcomers often struggle. Perhaps this is why the LinkedIn guy asked me to pick my brains. He knows he needs supremacy.

Some asset managers have it. So the first question for LinkedIn representatives is:

The best path to ETF success these days is avoiding competition, not product differentiation. Wealth Management Affiliates can direct their clients’ investment towards their products. These related assets have increased their share of his AUM in ETFs, especially for companies that have entered his ETF business over the past decade.

The Schwab Fundamental US Small Company Index ETF (FNDA-US) ownership map shows how asset managers can avoid market competition. Robo-advisor Schwab Intelligent Portfolios conveniently selected his FNDA out of 72 of his ETFs that provide exposure to US small caps. As a result, Charles Schwab Investment Management (CSIM) holds his 72.12% stake in FNDA.

Source: Factset

As of September 30, related assets account for 18% of AUM in Schwab’s ETF lineup. Schwab is his biggest ETF issuer to leverage the wealth business in this way, but not the only one. Many asset managers support his ETFs in this manner. New entrants are increasing their reliance on in-house assets, as shown in the chart below.

Source: Factset

The trend is clear. As the competition heats up, companies with a pre-identified investor base will have a clear edge.

Note: AUM statistics for the rest of this article do not include related stocks and convertibles unless otherwise noted. AUM listed as of September 30, 2022.

Most ETFs Fail or Decline

That edge really matters. Without it, companies face steep odds and steep enough to shock LinkedIn reps. The chart below, showing recent AUM for every US ETF company that has ever existed, paints a picture of the struggle.

Source: Factset

80% of all ETF issuers ever launched in the US have either disappeared or are in decline. With more ETF issuers below $1 billion and even fewer above $5 billion, withdrawing associated assets makes the ETF failure story even more vivid. Only 20% of ETF issuers crossed the $1 billion threshold and only half reached the $5 billion level.

Note: Excluding assets converted from SMAs swapped to mutual funds or ETF wrappers, the AUM for the two issuers is zero, so the unaffiliated closing rate is higher than the headline rate.

Due to first mover advantage, the distribution of ETF success is even more skewed than the manager success graph suggests. His largest ETF is mostly managed by a handful of companies that got into his ETF business before 2010. These first movers manage trillions of dollars, but the newcomer struggles to collect his first billion dollars. If I had to pick just one chart to show my LinkedIn representatives, it would be the one below, showing first-mover advantage in the US ETF business.

Source: Factset

The trend line shows that the first-mover advantage of companies entering the ETF business since 2010 is approaching zero. Since then, even the most successful new entrants have raised between $10 billion and $20 billion per deal (unrelated, excluding mutual fund conversions). Even the modest successes of amassing just a few billion dollars have become elusive.

To see the impact of first-mover advantage on ETF business these days, we need a graph like the one below in billions, not in trillions like the one above. This next chart measures success in the Survival, $1 Billion, and $5 Billion tiers. Still, it paints a grim picture for new ETF entrants.

Source: Factset

New is a relative term. His first decade in the US ETF market was full of opportunities. His next decade had many opportunities, but success was less assured. Over the past decade, competition has become overwhelming and success has become the exception rather than the rule.

Early entrants, especially the Big 3, have launched products that are the building blocks of their core portfolios. They have introduced a simple, easily explained, and hard-to-beat product into his ETF world. The availability of these products led to their ubiquity, creating a reputation and awareness of his ETF brand that is now almost impossible to replicate. In short, early entrants chose fruits that were readily available. Their followers have to be creative.

But creativity, often referred to as “product differentiation,” is not the golden ticket to ETF success. Bad results, including closings and his solid sub-$1 billion fortune, have increased dramatically over the past two decades. The LinkedIn guy’s trust in differentiated products is probably misplaced and could be fueled by conversations about a few winners.

beat the odds

Indeed, some of the new entrants to ETFs over the past decade have had clear successes. Cathie Wood’s ARK Investments was launched in 2014 and has $13 billion in assets under management (as of September 30, 2014). In 2015 she was followed by $15 billion Pacer Advisors. In 2018, $12 billion American Century joined the fray. In 2020, we switched some of our longtime mutual funds to ETFs.

A handful of companies are making between $5 billion and $10 billion. In 2013, KraneShares and Janus Henderson also entered. In 2014 came Crestview (VictoryShares and USAA). Innovator started in 2015.

What explains the competitive success of these few companies? When a LinkedIn rep asked me to pick my brains, he may have been asking this very question. not. I found some answers: loyal customers, sales force, media attention, and luck.

Some of the biggest ETF winners of the last decade, including Dimensional, American Century and Capital Group, have drawn loyal mutual fund clients into the ETF world. Renowned for its Fanboy Advisor Club and extensive investor education, Dimensional has reduced costs and increased access for investors by converting successful mutual funds into his ETFs. American Century and Cap Group have hired their experienced ETF practitioners Ed Rosenberg and Holly Framestead respectively to jettison him into the 21st century. (Ed left American Century in November 2022).

Pacer ETF understands that differentiated ETFs are to be sold, not bought, and have invested heavily in their sales staff. Pacer also grew through acquisitions.

ARK Investments CEO Cathie Wood has become a media darling, fueled by ARKK’s staggering 2020 profits. Even when ARK’s money plummets, the press can’t get enough of Kathy Wood. Her Cathie fans, like Dimensonal’s advisors, are very loyal.

Toroso Investments, a $2.3 billion ETF white label platform, is also playing the media game with ETF Think Tank.

Some ETF issuers make their money by offering exposures tailored to the moment. Innovators with options strategies are very attractive to nervous investors who have invested heavily during market downturns. US Global Investors has taken off with his ETF that offers exposure to the airline industry. Anyone who has been on the plane in 2022 can understand the recent allure of this niche exposure.

back down to earth

But the reality is that for every big success, there are multiple asset managers that have failed. In 2014, 10 asset managers apart from ARK and Crestview launched his ETF line. Currently, four have left the business, three have less than $1 billion in assets under management, and three have AUM between his $1 billion and his $1.5 billion. Founded in 2014, RealityShares is aptly named with his AUM of $160 million. The competitive realities of the ETF market forced them to share the opportunity.

Jillian DelSignore, Head of Strategic Growth and Solutions at FLX Networks, helps new entrants do what they do best to acquire loyal customers, develop a distribution strategy, and focus on digital engagement and branding. , suggests investing in all approaches. And build media power.

Without a deep and loyal investor base, the capital to invest in experienced ETF sales, or an outsize media savvy, ETF entrepreneurs must be very lucky to be successful in the ETF business today. yeah.

LinkedIn representatives defined success as reaching $500 million in AUM over a three- to five-year span. In 2017-2019 he achieved this with 25% of companies entering the ETF market. The remaining 75% don’t have it. Median new issuer AUM for these years was just $37 million, $159 million, and $50 million.

What would you tell a LinkedIn guy?

I hope the data I have presented will inject some realism into the ETF entrepreneurship debate and help potential entrants enough to make an informed decision.

Their time is precious and limited just like all of us. I hope we all use our days on earth wisely.

So far, I haven’t seen a LinkedIn guy company register an ETF with the SEC, but we’ve only been talking about it for a few months. Do you think he will try it in 2023?

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