The note highlighted a number of factors that was driving this shift including the increasing availability of more low-cost ETFs and the growing popularity of robo-advisers among young investors.
Furthermore, Cerulli said the introduction of the Market Making Incentive Scheme (MMIS) by the Tokyo Stock Exchange in July 2018 had aided in improving the liquidity of ETFs while version 2.0 of the regulation, which came into play this year, is aiming to develop “star” ETFs.
Over the past five years, assets ETFs in Japan have more than tripled, rising to $304bn in 2018.
Despite this however, the market continues to be dominated by the Bank of Japan, which started purchasing ETFs as a monetary policy tool in 2010. The BoJ now control 93.9% of total ETF assets.
It is not yet known what impact this could have on the Japanese ETF market however, in April, BoJ Governor Haruhiko Kuroda warned authorised participants had highlighted issues around market making due to lack of inventory.
This prompted the Bank to consider launching a lending facility for its ETF buying programme, which would see it lend stock to APs.
Individual investors still only represent 2.7% of total ETF assets in Japan, however, Cerulli said there are industry efforts to improve this.
One way of promoting ETFs to retail investors, the report said, is through ETF-incorporated mutual funds.
It noted ETFs are being used in multi-asset funds or fund wrap programmes, as well as on robo-adviser platforms.
Ken Yap, managing director, Asia, at Cerulli, commented: “With online distribution becoming an effective tool for mutual fund sales, robo-advisers using ETFs in constructing portfolios for investors have a role to play.
“However, large domestic asset managers with extensive distribution channels still have an advantage over robos, whose assets are still small.”
ETF issuers from abroad are viewing this as a major opportunity, the report said. As well as improving the liquidity of ETFs, MMIS eases the entry for offshore managers into the market, as firms that want to be designated market makers can register with the Financial Services Agency (FSA), regardless of their HQ.
This has led to seven firms being registered as market makers, as of July, with more awaiting approval from the FSA.
Furthermore, in May, China and Japan launched a cross-border investment scheme linking both markets through ETFs, the Sino-Japan ETF Connect.
Under the east-bound leg, this enables Chinese managers to set-up Shanghai-traded ETFs that invest at least 90% of assets in Japan ETFs.
The report added current foreign ETF managers are mainly focusing on institutions however, some are turning towards the long-term prospects of the retail market.
Yap concluded: “With the growth in the number of ETFs, product differentiation will become increasingly difficult. Moreover, it takes time to build the business, as margins are thin.
“For asset managers, efforts to reduce the costs of investing in ETFs, in order to provide higher total returns for investors, will become more critical than ever.”