ETF Allocation Looks Ready to Rise

The average exchange-traded fund (ETF) allocation in advisers’ client portfolios is expected to rise to 7.8% in 2013, according to Cerulli Associates. 


Growth was stagnant in previous years, according to the Boston-based global analytics firm—7.1% in 2011 and 2012.

“This is notable because growth has been stagnant in previous years,” said Alec Papazian, associate director in Cerulli’s asset management practice. “Adviser adoption of ETFs continues to be the foundation of growth for the industry.”

According to Cerulli’s report, “Exchange-Traded Fund Markets 2013,” as of 2012, total ETF assets stood at $1.3 trillion, growing 27.3% for the year and boasting an astounding 10-year compound annual growth rate (CAGR) of 29.3%. For comparison, open-end mutual fund assets grew 15.8% in 2012 with a 10-year CAGR of 9.6%. Even more promising was the record flows into ETFs in 2012 after three consecutive years of positive but flat inflows.

Investors poured $184.4 billion into the funds last year (though it should be noted that open-end mutual funds drew $238.7 billion in comparison). ETFs are a true success story, poised to achieve even grander heights in the future, the report said.

“Almost two-thirds of wirehouse advisers report using ETFs, the highest percentage out of all the channels,” Papazian said. “More than half of registered investment advisers (RIAs) are using ETFs, and fewer than 50% of advisers in the remaining channels use ETFs. Even with the vast increase of ETF assets and adoption in the last decade, there is still room for growth in some of the largest adviser channels, including regional and independent broker/dealers (IBDs).”  

Advisers Need Support

According to Cerulli, understanding how use differs among adviser channels and what type of support advisers value is imperative for sponsors to expand assets. 

Adviser adoption could be one challenge, Cerulli said. Sponsors often assert that the ETF is a superior product vehicle to a mutual fund, but these funds are still new to many advisers and a large swath of retail investors. Some advisers will likely continue to prefer mutual funds for a diverse set of reasons, including those advisers who prefer active management, the report found. 

Decades of mutual fund use bring a comfort level that ETFs do not yet offer. The continued lack of penetration in the defined contribution space means that, at least in the near term, there will be demand for passive investing in both vehicles. However, it is clear that for most the preferred vehicle for passive investing is an ETF, as index ETF flows have outpaced index mutual funds every year since 2003.

However, discussion of these products as challenging the dominance of mutual funds is quite premature. Open-end mutual fund assets stood at $9 trillion at year-end 2012. ETFs are competition for mutual funds and active managers, but there is still significant ground between these two products. ETFs have yet to gain traction in some distribution channels, most notably defined contribution plans, which could eventually drive growth even further..

ETF providers are rightfully bullish on the future opportunity for their products. When asked to rate the level of asset growth they expected for the ETF industry in 2013, 63% predicted that asset growth will accelerate. The rest assume that growth will remain steady, which is still very positive considering the high rates of growth exhibited in the space over the last decade. No sponsor predicted a slowing of growth or decline of assets.

Assets Projected to Grow

Cerulli projects that ETF assets will grow to more than $2 trillion in the next two years and reach $4 trillion in 2017. Offering ETFs will not work for every manager, but all asset managers will need to design their product development and distribution with competition from these products in mind. As ETFs enter their third decade, the question is not whether the vehicles will continue their impressive growth, but instead whether they can penetrate new channels and establish themselves at the core of the investment management industry alongside mutual funds.

Another challenge is the relatively low use of ETFs within 401(k) plans. At year-end 2012, Cerulli estimated that 401(k) plans held $3.6 trillion in assets. Though ETFs continue to grow at astounding rates and penetrate the market, their failure to penetrate 401(k) plans is the prime example of a future opportunity to accelerate growth even further. If ETFs are ever going to reach the asset levels of mutual funds, cracking this market will be essential.

While there is clear potential for growth in a variety of institutional channels for ETFs, only 13% of sponsors predict institutions to be their primary source of asset growth in 2013. Cerulli asserts that, at least for now, broad institutional ETF distribution will remain available only to the largest sponsors. This does not mean that a smaller ETF sponsor should completely write off institutional clients.

“Exchange-Traded Fund Markets 2013” focuses on distribution and development trends in the ETF market, including active ETFs, institutional distribution, marketing and staffing, and the quickly growing ETF strategist space. The report is available for purchase at Cerulli’s website