ETFs Are Hot: Is This Just The Beginning?

Pension and Investments Online published an article last week discussing some of the developments happening in the background of the ETF industry. So much of the focus has been on new product development and asset growth, however this is clearly having an effect on other parts of the industry.

Certainly, the management at mutual fund manufacturers must be considering the purchase of ETF providers, as well as hedge fund managers, to help gain access to the two poles of the investment spectrum. They may not go full throttle to the pure separation of beta and alpha, but being “stuck in the middle” is a term many students of first year economics will recall. Recent news of Power Corp of Canada (holder of various finanicial services companies) buying Putnam Investments (PGM) for US$3.9 billion makes me wonder what will be the stimulus that leads to major investment firms lining up to buy ETF providers.

No surprise then that the VCs and private equity firms are ahead of the curve … not difficult compared to the mutual fund dinosaur. Still, I find this sentence in the article interesting:

That growth rate has venture capitalists and merchant bankers looking for the next hot ETF provider.

When I think of “hot” in the investment space I think of the dot.com IPOs of the 90’s or hedge funds of the past few years. But a hot “ETF provider”? You’d think we’re talking about alpha! We’re still talking about boring ol’ beta, right? I guess beta really is hot and the proof (new products, exponential asset growth) is the pudding that should not make this a surprise. However, this leads me to believe that the growth both in number of new offerings and assets under management we have seen in the past few years will easily be eclipsed in the next year or two (or more). This will especially be true on a global scale as there are so many international markets that have yet to be “ETF’d”. Consider how international real estate just became online as an ETF last month.

Of course, this bull market that has got to be one of the longest in terms of duration (but not actual percentage gain), however it will obviously have to end at some point in time and with potentially significant downside. Depending on the scope of a correction, how the ETF industry is affected by this will, in my opinion, be the most important development in this area for this decade. My guess is that it might cause a slight hiccup in terms of asset gathering but it will be very hard to turn this ship off course.

Comments

[Preshit Mulay:]

nice article Richard!
So do you think that in the down turn, Mutual Funds might probably be the ones who might do well?

2007 Jan 12 02:28 PM

[Richard Kang1:]

PM
In this globalized world, correlations seem to be moving higher among asset classes and even active strategies. Thus, in major downturns, I wouldn't be suprised to see something similar to this past summer when most investors were hurt in many parts of their portfolio. Broad market ETFs will obviously fall with the major market indices but it will be interesting to see just how many of the sectors remain relatively buoyant during that time (if any). I don't expect mutual funds to do that well unless it's a fund that either allows some amount of shorting or relatively high cash balances. At the other extreme are the hedge funds. Their performance has been rather lacklustre during the past 4 years' bull market. No surprise there. It is during major market declines that we've seen hedge fund indices perform well compared to the broad equity indices. Whether one's particular hedge fund investment will provide that level of value during a time of severe distress is as hard to predict as one's ability to effectively select the right mutual fund investment.

2007 Jan 14 10:17 PM