ETFs: Looking Toward 2010

For the global equity markets, 2009 was a time of hesitant recovery, but for the ETF industry, it was yet another record-breaking year.

Assets under management for U.S.-listed exchange-traded products swelled to $707.4 billion¹, a 43.5% increase year-over-year. The number of listed ETFs grew as well, to 796, and total net inflows for 2009 topped $72.2 billion.

Of course, not all of the news has been good. By mid-November, 42 ETFs had delisted². But with major new companies like Charles Schwab, Jefferies and BlackRock entering the ETF market for the first time in 2009, most see the delistings as classic product rationalization amidst a broader field of growth.

Dominant Themes of '09

Investors' continuing unease with the U.S. economy in 2009 has been reflected in their preferred choices of ETFs: Year-to-date, fixed-income, commodity and international equity ETFs have attracted the bulk of investor dollars, while long U.S. equity ETFs suffered $30.1 billion in net outflows.
Economic concerns have also driven the growing popularity of bearish short-term funds. So far in 2009, investors have withdrawn $5.7 billion from leveraged long-only ETFs, but have invested $19.9 billion into inverse products.

Product innovation wasn’t confined to the headline-grabbing leveraged and inverse products, however. 2009 also saw an explosion of ETFs targeting narrower sectors and themes, as providers scrambled to distinguish their products in an increasingly crowded marketplace. New product launches included state-specific ETFs, frontier-market equity funds, small-cap emerging market funds and even ETFs designed for Shariah-compliant Islamic investors.

The most popular funds to launch in 2009 were the Market Vectors Brazil Small-Cap ETF (NYSEArca: BRF) with $497 million in assets; the Vanguard FTSE All-World ex-US Small Cap ETF (NYSEArca: VSS) with $448 million; and the ETFS Physical Swiss Gold Shares (NYSEArca: SGOL) with $283 million. Despite this deluge of new funds, most assets remained concentrated in the largest ETFs; combined, the top 10 funds of 2009 held 39.7% of total global assets.

Growing Competition

One important trend from 2009 is that increased competition and greater discrimination on the part of investors may be eroding first-mover advantage. For instance, the dominant iShares MSCI Emerging Markets Fund (NYSEArca: EEM) lost considerable market share in 2009 to Vanguard's less expensive MSCI Emerging Markets Fund (NYSEArca: VWO). Year-to-date, EEM has seen net inflows of $3.6 billion, while investors poured $6.4 billion into VWO; EEM's assets under management now stand at $35.0 billion, vs. VWO's $15.9 billion.

Similarly, the low-priced ETFS Physical Silver ETF (NYSEArca: SIVR) has taken market share from the dominant iShares Silver Trust (NYSEArca: SLV) since launching in July.

The growing popularity of funds like VWO and SIVR signals investor desire for inexpensive products, which many new entrants to the marketplace hope to satisfy. In November, Schwab launched its first four ETFs. While the company's filings resemble some existing funds, they are priced more cheaply and can be traded without commissions for their clients. That latter fact could be a game-changer, according to some in the industry.

Some trouble spots have appeared in 2009. Regulatory pressures have caused several commodity funds to halt the creation of new shares, and forced the PowerShares DB Crude Oil Double Long Oil ETN (NYSEArca: DXO) to close.

But as the marketplace grows and large companies employ their full marketing power to promote ETFs, general awareness will undoubtedly increase. That, in turn, could help drive ETF growth in 2010 and beyond.

¹Unless otherwise noted, all data courtesy of the National Stock Exchange, as of Oct 31, 2009.
²Barclays, "ETF Landscape Industry Review: October 2009"