The range of ETFs continues to grow and advisors are graduating to the next level of sophistication, from the traditional use of gaining quick access to a sector or country, to now delivering alpha to clients.
Last year 134 new ETFs launched bringing their number to 938, according to Morningstar. Their assets totaled $785 billion, up 47% from $533 billion in 2008. For historical perspective, 2002 ended at approximately $100 billion. "The big trend for 2010 is more, more, more," says Scott Burns, director of ETF research at Morningstar, which places ETFs and exchange-traded notes (ETNs) in the same category. "More providers entering the space, more innovation, more alternative products, more assets, more [interest] from advisors and investors in general," Burns says. He insists that "2010 will be a big year for growth in a lot of different areas."
To keep up, Morningstar quadrupled the size of its ETF analysis team to 13 over the past 18 months. It covers 330 ETFs, which have about 97% of the assets under management. Burns says his team of analysts deals with advisors who want to use ETFs for portfolio construction as well as those who want to analyze them as trading vehicles in terms of liquidity and cost.
A wide array of asset managers that have not previously offered ETFs have leapt into the fray. Goldman Sachs, T. Rowe Price and John Hancock all recently filed with regulators to offer them. And bond giant PIMCO unveiled two fixed-income ETFs this year. Schwab began to offer its own ETFs last year, and Fidelity now allows investors to trade a list of 25 popular ETFs commission-free.
Valerie Corradini, director of the private client group at iShares, one of the biggest ETF providers, notes that ETFs are about the only area in asset management still growing, with projections for continued growth rates of about 20%. "This might be the next category where every asset manager says, 'I can't not be in this business,'" she says.
Established players like iShares and Vanguard continue to round out their product offerings, with Vanguard rolling out eight new fixed-income ETFs at the end of last year. Now owned by BlackRock after being bought for $13 billion from Barclays last year, iShares is launching emerging market sectors, with ETFs tracking the Polish market, as well as alternative strategies.
But the appetite for subdivision of sectors is not unlimited. Tom Roseen, an analyst at Lipper, points to the demise of some other niche offerings, like ETFs that covered only companies involved in breast cancer research and patient care services. "There wasn't enough volume for them to be profitable and keep up the business," he says. With niche investments comes concentration risk. The first ETF to cover the local Israeli market, the iShares MSCI Israel Capped Investable Market Index Fund, for instance, has one holding, Teva Pharmaceutical, which accounts for one-fifth of the portfolio. And the iShares MSCI Mexico Investable Market Index Fund has 23.8% of its assets in America Movil SAB, Latin America's largest mobile phone company.
Burns notes that the industry's rapid growth over the last decade continues apace even as many other areas of asset management have slackened, because advisors' habits are changing. Financial advisors are moving to asset allocation strategies, and they are increasingly using ETFs to execute them, he says.
Then there are the ETFs that help risk-hungry investors double down. Using derivatives, these funds make bets with leverage, promising to deliver two or three times the return or the inverse return of a particular index. Burns believes that hedge funds are some of the biggest users of these specialized ETFs. Burns notes that after many of them had their credit cut off by banks, leveraged ETFs provided a way to continue to generate returns with borrowed money. Of course, leverage can help a lot, but it can hurt a lot, too. Morningstar data shows that for the 12 months ended Jan. 31, the best performing ETF, the Direxion Daily Emerging Markets Bull 3X shares, jumped a whopping 237.51%. But the worst performing ETF using leverage, the Direxion Daily Financial Bear 3X shares, bled 96.06%.