Name: Douglas Yones
Title: Head of Exchange-Traded Products, New York Stock Exchange
What’s behind the recent surge in the popularity of ETFs?
The growth of ETFs in the past few years has been remarkable. Looking just at the U.S., for example, ETF assets under management (AUM) crossed a milestone of $4 trillion in 2019. Now, less than two years later, that number is nearing $6 trillion. The market remains incredibly active as issuers and investors both increasingly take advantage of the ETF investment structure.
The key benefits of the ETF wrapper have always been lower infrastructure costs, greater tax efficiency for the fund, instant diversification in a single trade and almost instant global distribution opportunities. ETFs offer an ecosystem that’s ripe for innovation, and that’s exactly what we’ve seen in recent years.
The ETFs that issuers have been bringing to market recently are often more creative and/or more complex in structure, from hybrid funds to sector products. In 2021, thematic ETFs especially have seen significant cash flow as investors seek to gain immediate exposure to emerging trends with greater investment flexibility. Issuers have their fingers on the pulse of the topics and industries that are moving the markets and making headlines and, alongside the rise of retail trading over the past 18 months, the fast-paced growth of assets in thematic ETFs reflects investor excitement in participating in these trends.
Another factor attracting new asset managers to the ETF market recently is the easing regulatory landscape. Notably, the Securities and Exchange Commission (SEC) adopted Rule 6c-11 in 2019 to modernise and standardise the regulatory framework for ETFs. The “ETF Rule,” as it is known, eliminated the requirement for asset managers to file for exemptive relief with the SEC when launching products. The result is a much more streamlined and cost-efficient path to market for traditional ETFs.
Also in 2019, the SEC approved several new active ETF structures that allow for selective holdings disclosure for active managers. This included the New York Stock Exchange’s Active Proxy Model, which is available for licensing. American Century Investments launched the first suite of these new ETFs in April 2020, and since then more than 20 other semi-transparent ETFs have come to market. The debut of these ETFs has kickstarted a tremendous period of growth in the broader active ETF market. It is emblematic of the ways in which the ETF industry continues to expand and create new opportunities for everyone involved.
Is the extreme growth in the active ETF marketplace just a trend?
The rise and success of active ETFs over the past year has upended a long-held belief that the ETF market is strictly for passive management and not a natural fit for active fund managers. Even before semi-transparent ETFs were a viable option, asset managers were generating alpha through actively managed Fixed Income ETFs. In reality, active managers have been involved and actively watching the space closely for years, evaluating the right time to tap into ETF strategies in an efficient manner.
Now that so many options for low-cost entry are available, don’t expect the growth in active to be a passing trend. As of the end of April 2021, year-to-date (YTD) active cash flow in the U.S. totalled $9.1 billion. This represents nearly 14% of total YTD ETF industry cash flows, eclipsing the active ETF market’s roughly 3% market share of AUM.
Semi-transparent ETFs had a particularly impressive first year, accumulating more than $1 billion in AUM by January 2021, less than a calendar year from the very first launch. Importantly, the growth is diversified. So far this year, there is year-over-year growth in all asset classes. More than half of active issuers broke quarterly cash flow records in Q1, and nine of the top 20 ETFs by cash flow YTD have launched within the last 12 months. This widespread success is indicative that the active ETF market will likely continue to flourish for some time.
Going forward, we can also expect to see more fund managers enter the ETF market through mutual-fund-to-ETF conversions. After a multi-year effort to approve and execute such a conversion in the U.S., Guinness Atkinson converted two actively managed mutual funds directly into NYSE-listed ETFs under its SmartETFs brand (ticker symbols ADIV and DIVS). While managers have long had the option to clone their fund strategies in an ETF wrapper, a direct conversion offers a more seamless transition by carrying over a fund’s track record and current assets. It is another way we expect to see more flows and activity in the active ETF market for the foreseeable future.
Are there hidden risks in the ETF ecosystem?
As in any rapidly growing market, investing, trading or even managing ETFs does not come without some amount of business risk. At the NYSE, we work directly with the U.S. regulatory bodies to ensure we’re providing the best possible trading environment that properly balances access alongside investor protection. This includes initiatives such as the Limit Up Limit Down (LULD) trading rules, market maker programmes for low-liquidity ETFs, new rule filings to ease regulatory filing hurdles, and developing a program for ETFs to list directly on the NYSE Trading Floor in order to gain the added benefit of a human Designated Market Maker.
For regulators looking closely at the market, it’s important to recognise the value ETFs continue to demonstrate every time the markets experience significant volatility, such as in March 2020. In equities, stressed market conditions saw investors turning to index ETFs as market indicators on days when futures were halted ahead of the open. In the bond markets, ETFs in some instances provided real-time price discovery for very illiquid underlying assets. This type of price transparency and real-time liquidity helps to dampen volatility and helps to support investor confidence amid times of great uncertainty.
The ETF industry will continue to break ground and enter new territory, as we’re now seeing with interest in cryptocurrencies and digital assets. As always, we are working in stride with the U.S. regulatory bodies to bring new product and investment ideas to market, which in turn promotes investor access, greater choice, and lower overall costs for the investment management industry.