Why ETFs are the future of asset management

ETFs are a better technology than mutual funds

Detlef Glow

a man in a suit

A number of market observers, including myself, have stated that ETFs have written a true success story over the last two decades and are set to continue this in the future. Even as this seems to be somewhat intuitive, these statements often miss a rationale why the trend toward ETFs will continue.

As a result, I want to shed a light on changes in consumer behaviour as a driver for the growth of ETFs, since the COVID-19 pandemic has changed the behaviour and expectations of consumers.

Even as I was always positive for the future of ETFs, the COVID-19 pandemic will accelerate the trend toward ETFs. Generally speaking, the rise of delivery services such as Amazon have changed consumer behaviour from going shopping in a mall or a single shop to ordering things from their computer, mobile phone, or tablet.

At the same time, Amazon raised the bar for their competitors with same-day delivery for a number of goods ordered on its platform. This also changed the expectations of consumers for their suppliers in general. Even as short delivery times were a nice gimmick before the outbreak of the COVID-19 pandemic, it became a very convenient feature which consumers found somewhat necessary when economies went into lockdowns.

These expectations will not change and consumers will start to think that fast delivery is a must for any type of goods and services, and real-time trading is one of the key features of ETFs. In addition to this, the COVID-19 pandemic led to higher online trading activity from investors around the globe, which may not change in the future. This is a trend that is also in favour of ETFs since mutual funds are not traded on exchange.

Another important point that may help to understand why ETFs will have a bright future can be seen in the change and the use of technology. While the majority of discussions around ETFs are based on the active versus passive debate, one can also see ETFs as a technology upgrade of mutual funds. This is true, as ETFs are a different type of mutual fund which have some key features, especially with regard to fund distribution, that were not needed when mutual funds started to get traction with retail investors in the 1950s and 1960s.

This process can be compared with the evolution and usage of TV sets, which also became popular during the 1950s and 1960s. At that time, TV sets used to be expensive and heavy goods with a small black-and-white screen, and the number of TV stations was quite limited. Nowadays, TV sets are comparably cheap and have large 8k Ultra HD screens that can display more colours than the human eye can see.

In addition to this, modern TV sets are so-called smart TVs which are permanently connected to the internet and allow the user to watch their favourite TV show or series at any time. With the increasing popularity of TVs in the living rooms of families around the globe, there was a massive increase of the number of TV stations and the variety of programmes. A number of these TV stations still stick to traditional broadcasting times for their most watched programs and restrict the online availability of these shows. This means they are also limiting the number of viewers. This also explains the success of streaming services such as Netflix, which have started to compete with traditional TV stations with on-demand services. This enables their customers to watch their favourite TV show whenever they want.

One may ask what this story has to do with the fund industry, but the relevance of this becomes obvious if one sees mutual funds as TV sets and the broadcasting companies as fund promoters, while ETFs are the 8k UHD TV sets and their promoters are the providers of streaming services. To put a bit more flesh on the bones here, mutual funds are rather expensive investment vehicles that have not changed much since their inception, and in most cases, are not available on every brokerage platform.

In addition to this, mutual funds cannot be traded at any time, so there is often a delay of one or two days between the order of a fund and the respective execution. Conversely, ETFs are transparent low-cost products which can be traded immediately in any online account with a connection to an exchange. This means that ETFs can be seen as very efficient vehicles for fund distribution, since their promoters can reach every investor with a respective online account. In addition, listing on an exchange makes the promoters of ETFs also independent from any kind of brokerage platform.

That said, the next question might be why do the promoters of active funds deny plans of launching ETFs instead of listing all their products on an exchange? The first and most obvious reason for this is the fact that a listing on an exchange may compromise the existing relationships between the fund promoters and their brokerage platform or financial advisers.

The more important reason for the reluctance of fund promoters can be seen in current fund regulations. While ETFs have to disclose their portfolio holdings in a quite frequent manner, mutual funds only have to publish their holdings in their annual and semi-annual reports. In addition to this, active fund managers see the holdings of their portfolios as intellectual property and are therefore reluctant to publish their portfolio holdings.

I assume that the promoters of actively managed funds will start to use the ETF structure as distribution wrapper once regulators around the globe align the reporting duties for holdings disclosure between mutual funds and ETFs. As we have already seen that first regulators are rethinking their policies to allow non-transparent ETFs, I imagine ETFs will become the vehicle of choice for the promoters of actively managed funds sooner rather than later, especially as we already have seen the launch of actively managed ETFs in several parts of the world.

Therefore, I predict that ETFs will replace mutual funds in the future, but only as distribution vehicle and not with regard to their management approach – passive versus active, as it is discussed by many market observers and participants nowadays.

Detlef Glow is head of Lipper EMEA Research at Refinitiv, a London Stock Exchange business

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