A changing landscape
A different model and new technology can drive ETF growth, writes Pedro van Gaalen
Due to market saturation in cap-weighted exchange traded funds (ETFs), issuers have sought to innovate to differentiate their offering, while also looking to deliver marketbeating returns.
A number of non marketcapitalisation index-weighting strategies have emerged, led predominantly by smart beta funds that leverage rules-based investment strategies.
Additional innovation has taken the form of active ETFs and funds that offer emerging market exposure, access to impact investing via environmental, social and governance ETFs or exposure to hypergrowth sectors such as cannabis, industry 4.0 technology or cryptocurrencies.
The pace of this market innovation also accelerated following the ETF industry’s race to the bottom in terms of pricing, believes Charles Savage, CEO at Purple Group. “Now that we have zero-rated ETFs, cost is no longer a differentiator. Issuers are grappling with how to differentiate themselves and compete on no margin.”
A shift to a platform-based business model seeks to improve the customer experience, and enables issuers to own the investor relationships from end to end, Savage says.
“Major issuers in the US like BlackRock and Vanguard are already building or buying platforms. Platform plays aim to craft a seamless, frictionless user experience, and often leverage bespoke content to enhance engagement by sharing exclusive research and providing investor education.”
These features resonate with millennial investors in particular, who are no longer happy to be passive passengers on their investment journeys, says Savage. “They want to be empowered with information and play active roles in the investment decision-making process. So those issuers that can deliver the right mix of functionality and usability via a platform stand to capture significant market share.”
This is also an important strategic move because ETF market diversification has given investors a broader universe of investment options. “It is therefore vital for investors to educate themselves about the risks involved in investing in sectors like hypergrowth markets to limit their exposure to volatile investments,” says Steven Empedocles, portfolio manager at Sygnia.
This ability to share information and engage and empower investors will help to elevate the perceived value of the offering, continues Savage. “Charging 1% then becomes more justifiable and palatable.”
Platform plays will also create opportunities to integrate new forms of technology into the value chain.
“A lot of noise has been made about the potential for robo-advisors to disintermediate the broker. But we’re seeing a shift to a hybrid model blending digital engagement, ideal for low-level tasks, with human interaction for higher-order advice and relationship building,” adds Savage.
Advancements in technology have also increased the efficiency of back-end systems, adds Empedocles.
Unfortunately, much of this innovation is happening in more mature markets and therefore remains some way off. “SA is a laggard in terms of driving innovation — it’s more of a market that tracks US trends,” says Savage. “But there are opportunities for those brave enough to innovate.”
For example, Sygnia’s Itrix 4th industrial revolution global equity ETF, which invests in companies that are paving the future of technological growth, has performed well since inception. “This fund is a great example of how industry 4.0 technologies can be leveraged,” says Empedocles.
Marijuana, or cannabis, ETFs are another example of how innovation can drive exponential growth. North American investors have piled into ETFs that track so-called “pot stocks”. “The marijuana industry is definitely a major African and SA opportunity, but only if governments move quickly to amend legislation and remove the red tape to make it commercially viable. Backed by ETF funds, this trend could light up the agricultural sector, create greater opportunities for emerging farmers, and stimulate the economies of countries such as SA, Lesotho, Swaziland and Malawi,” says Savage.
“Unfortunately, this ideal remains some way off. Even with legislative amendments, local demand, which is limited due to the relative size of the investor pool, will ultimately dictate how much local issuers are prepared to innovate.”
ETF market diversification has given investors a broader universe of investment options
Charles Savage … a range of options