The first major ETF was launched in the early 90s with a tracker of S&P500 on the NYSE. This wrapper has since grown immensely and the global ETF market is close to $3trillion. It was a disruption to the mutual fund world and continues to grow. There are over 5000 ETFs on over 60 exchanges worldwide. The major providers of ETFs are State Street, Lyxor Asset Management, iShares, Vanguard and ETF Securities. I wont go into the variety of advantages that different types of ETFs offer to investors (lower fees, tax efficiencies, liquidity etc) because I am mainly interested in the ETF space as it relates to Fintech disruptions.
The ETF space in Fintech time warp, is actually a mature conventional financial structure. I am looking for Fintech elements in ETF land:

• The BATS exchange in Kansas, is a privately owned US exchange which handles a lot of ETF trading (and maybe ¼ of the listings of US ETFs) and is the third largest one in the US. BATS created a marketplace, the ETFs BATS ETF Marketplace, which will pay ETF providers to list on their exchange (depending on volume traded)! ETF providers usually, have had to pay between $5,000 and $55,000 a year to list on a stock exchange. Is this a wrapper of a kick-back scheme?

• The first ETF, ARK Web x.0 ETF (ARKW | D-30) that has invested in Bitcoin with an allocation to bitcoins obtained through publicly traded shares of Grayscale’s Bitcoin Investment Trust (OTCQX: GBTC); is offered by Ark-Invest (a NY startup focused on thematic investing).

• Motifs via Motif investing could be considered as a disruption to ETFs because:
  • Motifs are alternatives to thematic ETFs or mutual funds
  • Motifs entail no management fees
  • Motifs entail a marketplace element

• Retail investing in ETFs has been growing along with Fintech startup growth; especially DIY investors are heavy users of ETFs.

• 99% of Robo-advisors (1.0 and 2.0) promote investing in ETF land. In the US this is already a $25billion business that is captive in ETF investing.

• Some of the more sophisticated online investing advisors, are offering dynamic algorithms to optimize asset allocation again using ETFs. Logical Invest is one such single provider that is heavily used form financial advisors (discussed in “Logical Invest offers actionable portfolio solutions; simple and intelligent”). Alpha architect, a US based startup offers their own actively managed ETFs using sophisticated quantitative algorithms for momentum investing and value investing.

• Mebane Faber, founder of Cambria, an independent asset manager, created this year the first no-fee global allocation ETF that is an actively managed portfolio across countries and asset classes and is ideal for those that don’t want to follow the markets at all. With no fee at all – the underlying ETFs however, do have a 29bps fee – the Cambria Global allocation ETF, should be compared to the alternative of holding some type of Vanguard lower fee global asset allocation ETF. Such ETFs entail 16-18bps fee but require that the investor manage over time the type of global asset allocation fund. Most ETF or fund providers of these products offer half a dozen of them (from those with larger holdings in bonds and less in stocks all the way to mostly stock holdings) and let investors shift between them; typically resulting in increased fees and suboptimal timing.

• Financial advisors for the most part, are not promoting ETFs (synonym with low cost alpha) because they feel it threatens their image of “adding value”. The majority of investors that use financial advisors and private bankers, have a taboo around discussing ETFs with their relationship managers. Switzerland for example, the private banking land, is a lite ETF user.

There is more room for AUM growth in the ETF space as investors become more DIY or more hands on with regards to their financial decisions.

Special ETFs will grow. More ETFs will focus on new crypto-currencies but the fees will remain on the high end for these “gourmet” wrappers (100bps-200bps). The ETF space will remain dominated by a dozen low cost ETFs. Over 99% of AUM in ETFs are with the basic buildings blocks: SPY, IWF, QQQ, IWM, GLD, etc.

Fees of ETFs will shrink to zero, as issuers compete and as exchanges compete for the business too. Robo advisors will offer services to investors that need to dynamically optimize their ETF holdings.

If Citi’s projections on the growth of robo-advised AUM in the US prove to be fairly accurate; then in 10yrs the $13trilllion of US unadvised assets will be captured by robos. If more than half of that, becomes captive to the ETF market, that will result in an estimated growth rate of over x25 times from current levels.

In 10yrs Robo-advisors could push ETF AUM from $3 trillion Globally to $75trillion.

By Efi Pylarinou