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ETFs to Infiltrate More Portfolios, 401(k) Plans

Leaders Predict 3,000 ETFs by 2011

WASHINGTON - Exchange traded funds (ETFs) have been growing by leaps and bounds lately, but you ain't seen nothin' yet, said a panel of executives involved in creating and distributing ETFs, speaking at the Investment Company Institute's general membership meeting here two weeks ago.

ETFs are now working their way into financial advisors' hearts and clients' portfolios as core investment product holdings because of their transparency, simplicity and ease of use. Moreover, once pesky operational issues have been worked out or circumvented and preferences for using only mutual funds are overcome, you can expect to see more and more ETFs elbowing their way into 401(k) plans, said the executives.

That includes passive as well as active ETFs.

"We are seeing advisors more and more incorporating ETFs into portfolios," said Bruce Bond, managing director and president of PowerShares Capital Management. "ETFs are becoming an important part of advisors' lives today."

Large, But How Large?

Worldwide, there are now about 1,100 ETFs with assets of about $800 billion, and 70% of those assets reside in U.S.-based ETFs. Those U.S.-based assets have collectively grown to $600 billion in 14 years - about a third as long as it took mutual funds to achieve that amount, Bond said.

Morgan Stanley is currently predicting that by 2011, U.S. ETF assets could exceed $1.4 trillion, with total global assets pushing the $2 trillion level, he added. Moreover, ETF asset growth is picking up momentum. In 2007, $151 billion flowed into ETFs, versus $74 billion the year before, Bond said.

Although ETFs represent a relatively small percentage of listings on stock exchanges, they represent a large portion of an exchange's trading volume, said John Jacobs, executive vice president and chief marketing officer of The NASDAQ Stock Market Inc. Billions of shares of ETFs trade daily, with the top 10 ETFs accounting for 75% of all ETF trading, he added.

"I think ETFs have been a driver of the capital markets today," Jacobs noted.

Challenges Persist

But while the ETF market has been growing to meet the appetites for them, challenges persist. For instance, seed capital for new ETF upstarts is growing scarcer. Additionally, there is still a learning curve among financial advisors to tackle, the panelists agreed.

Many financial advisors want to understand precisely what ETFs are and how they work within a portfolio, panelists noted.

"There's a huge amount of work to be done to go from awareness and understanding to use," said Anthony Rochte, senior managing director with State Street Global Advisors. He predicts that a potential future bad bear market may propel advisors to ask about using more ETFs as their low fees are appealing.

Furthermore, he noted that as far as product development goes, many of State Street's ETF ideas come directly from financial advisors. Some of the best ETFs on the market today are those that can tap certain markets and asset classes that would otherwise be unattainable, he added. He estimated that about half of ETFs' collective assets are from institutional investors.

Greg Friedman, managing director at Barclays Global Investors said that going forward, ETFs - including Barclays' iShares - will be woven into more solutions-based products for advisors who are seeking help in finding the best ETFs to use as core and/or satellite investments.

To get more exposure for its iShares ETF lineup, Barclays debuted a new 2008 multi-media advertising campaign in late April that includes TV, print, online and outdoor ads. These ads will run through June, take a summer break, then reappear in the fall, a Barclays' spokeswoman confirmed.

The Next Wave

Watch for additional ETFs to come to market, the panelists said.

Jonathan Steinberg, CEO of Wisdom Tree Investments, predicted that three years from now we could be looking at 2,000 to 3,000 total ETFs, including new waves of active ETFs.

"Some will not succeed," he predicted. "But that doesn't demonize our industry. They are just like mutual funds, hedge funds...some live, some die."

ETFs will be able to "do well only if they are immensely successful in the execution of their plans," he said. "The market will choose the winners and losers."

While active ETFs will undoubtedly unlock creativity and specialization, Steinberg urged restrained judgment. "Don't judge the success of actives by the first wave of active ETFs," he cautioned. Last week Wisdom Tree was scheduled to launch a series of active currency ETFs in partnership with Dreyfus Corp.

The Real Challenge to Infiltrating DC Plans

As for ETFs becoming a mainstay offering among 401(k) plans, it's not difficult to structure plans to accommodate ETFs, Steinberg said. Late last year, Wisdom Tree launched a platform to allow for both mutual funds and ETFs to peacefully co-exist within a 401(k) plan (See MME, Oct. 14, 2007).

The real problem lies in convincing plan sponsors for the need to reconfigure a system that will allow for the inclusion of ETFs. Just look at the American Funds which has such a large 401(k) business but no ETFs, Steinberg noted.

"There is no incentive among employers to change," he said. "You may have some initial resistance. It takes time to get the plumbing going."

(c) 2008 Money Management Executive and SourceMedia, Inc. All Rights Reserved.