Professionally managed financial investments globally are predicted to grow at 6% per annum to reach $100 trillion by 2020, according to a new report by PwC. Exchange-traded funds (ETFs) will pay a prominent role in this growth, as new investor segments continue to integrate them into their portfolios and fund sponsors continue to introduce more products.
A report from accounting and consultancy firm PwC reveals that more than three out of four asset management industry executives expect ETF assets to at least double, to reach $5 trillion or more by 2020.
The report, ‘ETF 2020: Preparing for a new horizon’ (“ETF 2020”), which surveyed executives from 60 ETF sponsors, asset managers and service providers around the world that account for over 70% of global assets, reveals more than three out of four executives expect ETF assets to at least double, to reach $5 trillion or more by 2020.
According to the report, asset flows in the developed markets of the US and Europe will continue to dominate the ETF landscape. However, the highest rates of growth will be found in the less mature markets.
Institutional investors are widely expected to be the primary growth driver with insurance companies, pension plans and hedge funds in particular, projected to be significant sources of demand for ETFs.
New types of “smart beta” indexing represent a hotbed of product development activity with 46% of firms surveyed identifying this as the most important area of innovation. PwC expects this to continue for the near term. Active ETFs (34%) and alternatives (29%) are also expected to be sources of significant ETF growth between now and 2020.
ETF sponsors are bullish on their financial prospects with 59% saying they expect their ETF business to become more profitable this year. According to PwC, upgrading technology, resources and processes will be critical as the ETF landscape becomes more global and advanced, with a wider array of investors and new investment strategies offered in ETF form.
The report highlights that service providers will need to continue to adapt their business model by adding resources, streamlining processes, introducing more automation, globalizing operations and upgrading technology.
The regulatory environment is widely believed by the survey participants to have a significant impact on the growth and innovation of ETFs over the next few years. 91% indicated that regulations and taxes impact ETF growth. PwC notes, however, that whilst new regulations could spark further growth if they permit further product innovation or lower distribution barriers; they could also dampen demand, particularly if new tax rules make ETFs less tax efficient.
In Europe, new regulatory initiatives will be some of the biggest drivers of change in the ETF business, affecting distribution dynamics and the product landscape in particular. MiFID II and Retail Distribution Review (RDR) are set to ban the use of commissions by independent financial advisors which to date worked against ETFs in the retail market. Going forward, active ETFs are expected to be a source of significant growth in Europe. According to PwC, more streamlined operations to facilitate the cross-listing and settlement could make European ETFs much more attractive and cost effective.
In Asia, traditional forms of passively managed ETFs are still viewed as a major growth opportunity in a market which is still relatively young. Distribution remains a challenge in Asia; however fund passports could have a profound impact on the success of ETFs. For example, the ASEAN passport for Malaysia, Singapore and Thailand, operational since August 2014, means retail funds (including physical ETFs), can be offered directly to investors in any three of these markets. Additionally, there is the Shanghai-Hong Kong Stock connect market access programme which could create additional opportunities for ETFs if they are added to its scope.
In the US, institutional investors, including registered investment advisors, wealth management platforms, other asset managers, endowments and foundations, are each expected to continue to expand their investments in ETFs between now and 2020. There continues to be a lot of interest in active ETFs, particularly in light of the Securities and Exchange Commission (SEC) approval of one version of non-transparent active ETFs. According to PwC, the SEC approval of additional versions of non-transparent active ETFs could lead to another phase of growth and innovation.
Nigel Brashaw, Global ETF leader, PwC, commented: “Shifts in the regulatory environment will continue to produce opportunities that will favour firms with local market knowledge. The ability to transform ETFs into effective solutions that address the needs of specific investor segments will be a particularly important factor in competing successfully.”
Bill Donahue, ETF practice leader, PwC added: “Despite myriad challenges, opportunities abound for existing ETF sponsors as well as other asset managers willing to develop a thoughtful and informed strategy as they prepare to address this market. However, as more types of investment strategies become operationally feasible and are permitted by regulators, firms will need to develop and retain deep expertise, differentiated products, investor education, and effective distribution channels to achieve success with their ETF offerings.”
PwC surveyed executives from 60 firms around the world in 2014 using a combination of structured questionnaires and in-depth interviews. Two-thirds of the participants were ETF managers or sponsors, with the remaining participants divided between asset managers not currently offering ETFs and service providers. Participating firms account for more than 70% of global ETF assets.