A new report from the professional services giant shines a light on the booming exchange-traded fund sector, and what will be the most prominent factors in years to come.

Nearly all asset managers will have an exchange-traded fund offering within the next five years, new research indicates. 

Two-thirds (67 per cent) of ETF market makers, service providers and promoters who collectively manage 85 per cent of global ETF assets “believe most managers will have an ETF offering in the next five years”, according to a new report by EY.

The report, based on interviews with market participants, suggests that ETF providers will face new challenges as the industry continues to grow in size and influence.

“ETFs can no longer just be cheaper or more liquid than actively-managed mutual funds,” said Lisa Kealy, a wealth and asset management ETF leader at EY. “The industry needs to innovate around investors, refine investor journeys and reduce investor costs to remain competitive.”

The report, titled Global ETF Research 2017: reshaping around the investor, comes as inflows into ETFs continue to reach record highs. It is estimated that by 2020, the global ETF market will be valued at $7.6 trillion. 

The ETF market will be transformed by both current and new investors, EY says in its report. 

The research suggests that 15 to 20 per cent of ETF inflows over the next three years will come from new investors, totalling some $250 billion. 

“Investors typically first turn to ETFs for selected exposures they cannot access elsewhere, but then become more comfortable using them as the building blocks of portfolio construction,” EY noted. 

Still, institutional investors will continue to dominate ETF investing, according to 97 per cent of interviewees. The report flags wealth managers, private banks and investment funds as “important areas” for growth. 

It also forecasts that pension funds are will increasingly use ETFs for liquidity management, while wealth managers will use them for core exposure through model portfolios. Certain hedge funds will use leveraged and inverse ETFs to execute high-conviction long or short positions, EY says. 

Passive investment vehicles, like ETFs and other exchange-traded products, are piling pressure on active money and fund managers because they offer high liquidity, wide market exposure and tax efficiency for minimal to sometimes zero fees. In the UK, for example, there is also pressure mounting from regulators who say its asset management sector does not offer good enough value for money and is largely not competitive enough. 

"The ETF industry needs to do more to help refine investor journeys for institutions by understanding and anticipating the long-term needs of different investment groups, addressing their concerns and developing the expertise needed to meet their unique challenges," said Julie Kerr, EY’s Asia-Pacific wealth and asset management ETF leader. 

EY’s research shows that 2.9 per cent of inflows are now pouring into funds with assets under management below $100 million. More than half (55 per cent) of respondents have said they did not believe the success ratio of new launches will improve going forward. 

Nonetheless, product development will continue to diversify, with ETFs taking many forms, tapping a higher number of themes, offering greater access to debt and investing in alternatives, the report suggests. 

Stoking what could already be considered an inferno, ETF fees are continuing to fall.

The average ETF fee last year was just 27 basis points, or 0.27 per cent, and the majority (71 per cent) of those interviewed expect fees to drop further as “becoming a low-cost provider becomes a prerequisite to survival,” EY said. This notion was echoed in the Alpine State earlier this year in a report by KPMG, which showed that between 60 and 70 Swiss private banks were fighting for survival and faced problems so serious they could be forced to shut shop or sell up.

Assets in passive funds will surpass assets invested in active funds globally in 10 years’ time and ETFs will “benefit disproportionately” from this shift due to their low fees and intraday liquidity in volatile markets, EY pointed out. 

Regulation driving change
Regulatory red tape will change the way ETFs are distributed, according to 61 per cent of interviewees. 

ETFs should, in theory, benefit from the shifting regulatory landscape, with initiatives such as the European Union’s MiFID II and the US Department of Labor Fiduciary Rule, both of which seek to inject more transparency into the fund management industry. 

But as the climate continues to change, there is additional scrutiny of the industry’s systemic risk and taxation, EY says. 

"The industry needs to address market and regulatory threats and be willing to respond by developing new products and modifying existing products,” said Matt Forstenhausler, EY global and Americas wealth and asset management ETF leader. “A combination of local understanding and global insights can help investors understand the overall business environment and how this will impact investor journeys."