The Future of ETFs: An Advanced Investor's Guide

Exchange-traded funds (ETFs) can be a simple, cost-effective approach to investing that provides diversification with a single, convenient, and easy purchase.

As of September 2023, the U.S. ETF industry had grown to $7.3 trillion from $4.3 trillion in pre-pandemic years, aided by the 2019 rule passed by the SEC to expand competition in the marketplace.

This is good news for investors looking to enhance their ETF portfolios and suggests further growth in assets as well as the number of ETFs. But where exactly is the ETF market headed in the future, and what are the trends investors should watch out for?

What Is an Exchange-Traded Fund?

An exchange-traded fund (ETF) is an investment vehicle that invests its funds in the same securities found in a particular benchmark index, sector, or other assets. By doing so, the ETF aims to track the return of that benchmark.

Features

• ETFs are like mutual funds in that they provide an investor with broad exposure to a variety of assets. For example, an investor may invest in a single technology ETF to gain exposure to many technology stocks.
• ETFs are passive investments when they track a benchmark. This means minimum transaction expenses and greater affordability than other investment funds, such as certain mutual funds and actively managed ETFs.
• In addition, they typically have low expense ratios.
• Popular ETFs are liquid securities, which makes them easy to convert to cash and diminishes the hidden cost of a wide bid-ask spread.
• ETFs trade intraday like stocks on an exchange. Investors can buy and sell them at any time during exchange hours. That's different from mutual funds, which have specific rules and requirements regarding selling and are priced only at the end of the trading day.
  

Where ETFs Are Headed

Since their introduction in 1993, ETFs have captured the interest and assets of investors. Retail and institutional investors have embraced the concept that asset allocation can result in better returns than those offered by individual security purchases.

According to asset manager BlackRock, ETF growth in 2023 reflects investment trends that support index investments as a primary strategy.

Index investing also continues to gain popularity as investors realize that the higher costs associated with individual stock investing erode long-term returns.

Additionally, as investors become active traders of their portfolios and wary of unnecessary advisory fees, low-cost index products such as stock and bond EFTs will gain additional traction.

New types of ETFs have also sparked intense interest in ETF investing. For example, on Jan. 11, 2024, spot bitcoin ETFs started trading in the U.S., having been approved by the U.S. Securities and Exchange Commission.

Growth in AUM and ETF Types

A PwC survey of global ETF executives indicates that global ETF assets under management (AUM) will reach a minimum of $18 trillion by 2026, and more likely, $20 trillion. It bases this outlook on the remarkable inflows of funds to ETFs, the new players entering the market, and the innovative products both in use and envisioned.

The survey points to crypto ETFs, thematic ETFs, commodity ETFs, and active ETFs as products that may satisfy the growing investor demand for new investment opportunities. Of the 543 new ETFs that launched in 2023, Morningstar found that approximately 75% of them were actively managed.

The Future of Asset Management

Asset managers, such as those that offer ETFs, have the opportunity to improve the way they do business, the quality of products offered to investors, and their financial results with emerging technology innovations.

AI and Risk Management

A 2023 report from EY (Ernst & Young Global Limited) suggests that financial firms may face hurdles without integrating more digitization and the use of artificial intelligence (AI).

AI technology can help fund managers improve the way they conduct their operations and interact with clients.

Additionally, asset managers who focus on risk management techniques combined with a high level of transparency will profit most.

The Bottom Line

ETFs have experienced significant growth since their introduction in 1993. They have proven an attractive option for investors looking to diversify their portfolios easily and at low cost, without increasing the time and effort they spend managing their assets.