Five jumps ETFs must clear for growth

PwC report says ETF providers must go beyond "business as usual."

November 20, 2013

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horse jump_edited-1Could the global exchange-traded fund (ETF) industry reach $5 trillion in assets under management in three years? Most certainly, according to a new report by PwC. It has been one of the most effective disruptors of the status quo, and it’s a story that’s just beginning. But if the ETF industry really wants to put down deep roots, providers are going to have to address a few key challenges, as more and more competitors enter the marketplace and as many new products face negative asset flows. As PwC notes, “Despite the positive developments and optimistic outlook, there is no denying that a business-as-usual approach is unlikely to lead to success in the future.”

So what are the big roadblocks to success for the ETF industry? PwC names five:

1. Cracking the retirement space is tough to do
ETFs haven’t yet made significant strides in the DC space where mutual funds rule. In the absence of any big ETF success stories in this segment of the market, mutual funds will likely continue to dominate says PwC.

2. The knowledge gap
Misconceptions about liquidity and trading volume continue to drag on growth, according to the report. It notes that 70% of ETF sponsors surveyed claim advisors equate the trading volume of an ETF with its liquidity and opt out because they believe they won’t be able to move large positions in and out of the space. More education will be needed to shift how ETFs are viewed.

3. Active ETFs are a challenge
Active ETFs are likely to drive growth in the space in the coming years as they appeal to a wider client base. But they’re much harder to launch than their passive counterparts—approval from the U.S. Securities and Exchange Commission (SEC) can take up to a year or more depending on the product. Daily transparency is also a sticking point, says PwC—traditional asset managers in particular have to divulge their mutual fund’s portfolio holdings quarterly. It’s not exactly an easy fit with the ETF model, which demands daily reporting. Any changes that do happen within an active ETF must happen fast—another administrative hurdle for providers.

4. Operational risks
ETFs have experienced rapid growth, and they’re relatively new in the marketplace. For investors, this has raised a few questions around operational risks as the industry struggles to catch up with the pace of innovation. On the operational side, PwC identities four main issues—misconceptions around trade failures; concerns about products based on alternatives such as hedge funds; liquidity for thinly traded ETFs, counterparty, infrastructure and new product risk to the overall market; and tracking error worries.

5. Regulatory roadblocks
While policy-makers in China, Japan and other major markets have welcomed ETFs with open arms, the SEC and the European Securities and Markets Authority are currently looking closely at potential risks such as disclosure and tracking error. This could lead to more regulation down the road.

Read the full report here.

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