The exchange traded funds market is forecast to draw in more assets over the next five years and Asia has strong potential to grow from a relatively small base at present, a study said.

There is no end in sight for the growth of exchange traded funds, with the Asian market likely to expand rapidly, according to PricewaterhouseCoopers.

Global assets under management in ETFs are expected to surpass $7 trillion by 2021, PwC said. To put that figure in context, private wealth globally stood at $168 trillion in 2015, according to Boston Consulting Group. The asset management industry held $71.4 trillion globally last year.

Many ETF providers are expected to expand their global footprint and offer ETF products across borders to compete outside their domestic markets. To succeed, according to PwC, firms must develop an understanding of local and global tax laws and regulations. Its observations were made in a report called ETFs: A roadmap to growth.

The market for these index-tracking vehicles has expanded rapidly in the US and Europe on the back of their attractions in charging relatively low fees, simplicity in many cases, and for giving investors rapid and simple access to otherwise hard-to enter markets. Wealth managers, for example, who face higher regulatory costs, have turned to ETFs as building blocks in portfolios. There remain controversies, however, around the use of so-called "synthetic ETFs" (see below) and the fact that in some illiquid markets, ETF returns will not exactly mimic an index.

Of all the major regions, Asia is the smallest, but is “poised for growth”, PwC said, as markets become increasingly integrated and regulations are brought up to date. Asian firms expect ETF AuM in Asia to reach $560 billion by 2021 – an 18 per cent annual growth rate over the next five years. Hong Kong survey participants expect annual growth of 17 per cent over the next five years.

Elsewhere, the North American ETF market is expected to grow to $5.9 trillion by 2021 (23 per cent cumulative annual growth); the European market is expected to grow by 27 per cent annually – reaching $1.6 trillion AuM by 2021.

“The global ETF market has a bright future ahead, but the next few years will not be without their challenges,” said Maria Tsui, Asia ETF leader at PwC Hong Kong. “The market is increasingly crowded, particularly in North America and Europe. Many firms are looking to expand their global footprint, which presents opportunities as well as challenges with respect to regulations, tax laws and establishing relationships with distribution partners. 

“Firms across the globe that wish to take advantage of the booming ETF industry will need to promote investor education, establish strong distribution channels and differentiate their products. Similarly for Asia, new and improved distribution channels, better investor education and further enhanced cross-border schemes are also seen as potential growth accelerators in the Asian ETF market,” she added. 

The rapid rise of ETFs in recent years has occasionally produced cautionary notes, such as over “synthetic ETFs”. These ETFs mimic returns of an ETF through use of derivatives such as swaps. Synthetic ETFs have drawn fire for their vulnerability to potential counterparty risk as well as complexity and the potential to confuse investors.

ETFs are securities that track an index or a basket of assets; in contrast to traditional index funds, which are priced once per day, ETFs are priced throughout the day, which allows short-sellers to use ETFs. Arbitrageurs can exploit pricing differences between ETFs and the underlying basket of stocks that the ETF tracks. A report by academics from the University of Notre Dame in the US said ETFs can make markets more vulnerable to shifts in sentiment, and hence be more volatile (source: Financial Times, 23 June 2013).