After going from $0 to $4 trillion in about 25 years, what’s next for the ETF industry?
MarketWatch recently spoke with Lee Kranefuss, one of the founders of industry giant iShares, about the state of the industry and where it may go from here.
MarketWatch: ETFs have been around for more than 20 years. What do you see when you look out to the next 20?
Lee Kranefuss: Well 20 years is a long time. I think one thing you might see is that fund launches will slow over time. More people will realize they can’t write a hit song.
The flip side of that is that a lot of money managers and institutions who missed out of the wave will come out with their own products. We’re starting to see that with J.P. Morgan Chase & Co.
and Goldman Sachs Group Inc.
which have recently launched their own ETFs.
MarketWatch: Has the space gotten over-proliferated?
Kranefuss: There are too many funds. Advisers come to us saying, “I don’t know about these, I don’t understand them, there are just too many.” The over-proliferation is supply driven, not demand driven, but I’m not inclined to say that there should be artificial constraints of some sort; I just wish people would be more rational about it.
MarketWatch: Is it possible we’ll see fewer funds as we look out into the future?
Kranefuss: I think we will. What determines whether a fund provider will be able to keep operating, or whether its funds will become zombie ETFs, is the diversity and breadth of the family it offers. If a smaller provider doesn’t have a healthy family of funds, you’ll see them close up or get absorbed into bigger names.
MarketWatch: Given the growth in the industry, has your answer to whether ETFs are putting the nail in the coffin of mutual funds changed?
Kranefuss: I think that active management, by which I mean security selection, is a dying business. It won’t ever completely die, because there’s some value to it, but I don’t think that traditional mutual funds are a growth field. It’s just too hard to pull real returns out of security selection, and the performance numbers are very damning.
MarketWatch: Is it possible that ETFs will become the venue for indexing while active stays in mutual funds, and that’s the primary different between the two?
Kranefuss: Certainly you’ll never see a big firm come out with index mutual funds ever again—that doesn’t make sense. They’ll go straight to ETFs, where there are advantages of scale and of being the first mover. Active management will stay in mutual funds. There will be a middle ground in retirement assets, some of which is being done in the form of life-cycle funds.
MarketWatch: What do you make of the smart-beta category, where the components are selected by rules designed to deliver specific strategies?
“We don’t need the hot new thing; we don’t need smaller players chasing hot spots of the market.”
Kranefuss:There are some interesting ideas in the category, but only a handful of documented factors—momentum, low-volatility, and so forth. You can easily implement those at the portfolio level. Value, for example, is largely a matter of sector orientation. There’s no need to spend more on a value fund. Most of these funds seem developed to stand out in marketing. There are always times when you can say something outperforms when back tested over a specific period.
MarketWatch: What are your concerns for the industry going forward?
Kranefuss: One issue that comes up is how there are both too many funds and too few. There’s a lot of concentration in the industry, but we’re missing some building blocks. We don’t need the hot new thing; we don’t need smaller players chasing hot spots of the market.
One example I give is with emerging markets. A lot of major EM companies have a high correlation to developed markets because they’re international. So why would you pay high fees to get exposure to a part of the market that has a high correlation to something you can get cheaply here? I can imagine a way of investing in emerging markets where you get the correlated part of the market through cheap domestic proxies, and then the rest is unbundled and purchased separately. That seems like a useful thing to have.