Asset managers looking to keep up with the ETF revolution are looking for ways to break into the ETF space. These days, the path to success seems ever narrower. Not only are the major market segments well-covered, and the potential fee revenue compressed, but market acceptance of new ideas is disappearing.
Launching new funds keeps getting harder. This trend manifests in the flat pace of new launches, the increase of closures, and, in the past few years, the dominance of bespoke and in-house funded products.
ETF launches are where innovation happens. Closures generally are a sign of health, as the market cleans up the flops and moves on. Closures can also signal a lack of opportunity, as they can indicate the limits of investor interest in a segment or strategy.
Over the past five years, the pace of ETF launches has flattened out, but the closure rate has increased. The joint launch/closure ratio, as shown in the chart below, indicates that asset managers’ sense of opportunity has diminished, while the willingness to throw in the towel has increased.
The decline in the pace of launches is not the only factor limiting success of new entrants in the ETF marketplace. New launches face increasing constraints on growth, as investors largely ignore them in favor of established funds. More and more, newly launched funds gather only minimal assets in their first year. Worse, a large majority of new launches close or get trapped by their low AUM.
The mountain chart below shows fund asset levels on their first birthday, sorted into bands, by year. The number of funds that accumulate less than $50 million or close up shop in their first year has been growing steadily since 2003. 81% of funds that launched in 2018 had less than $50 million in assets by the close of the year, while only 2% cracked the billion-dollar mark. The market has been getting tougher for years.
While many asset managers expect inflows after a fund achieves a certain level of seasoning, perhaps three or five years, the data shows that such expectations are largely unmet. It turns out that fund assets at the 12-month mark are strongly predictive of current asset levels, as a study of all funds launched between 2007 and 2016 reveals.
This next series of charts answers the question “where are they now?” by comparing asset levels at each fund’s first birthday with December 2018 levels.
Of the ETFs that had less than $50 million in assets at one year, 44% have since closed, with another 30% stuck in the under $50 million range.
Funds That Had Accumulated Less Than $50 Million After Their First Year
This next chart shows the opposite case: the present-day fate of funds that had $1 billion or more in AUM at the 12-month mark. Just a handful closed while over three-quarters stayed in the billion-dollar-plus zone.
Funds That Had Accumulated More Than $1 Billion After Their First Year
The overall direction is clear: the lower the assets at the end of year one, the higher the chance of closing, or of bumbling along at low asset levels. The opposite also holds true: the higher the assets at the end of the first year, the greater the chance of the fund thriving in years to come. There is greater mobility among funds that gathered mid-range asset levels in their first 12 months.
The next chart shows the results for every starting asset band. Current asset ranges are shown on the x-axis (horizontal), sub-grouped by 12-month asset levels. The y-axis (vertical) shows the percent of funds from each 12-month asset band that have landed in their current band. Put another way, the x-axis shows where the funds are now while the y-axis shows where they were at their first birthday.
In the past few years, organic success in the ETF market has become nearly impossible. Of the ETFs launched in 2017 and 2018, only nine have amassed $1 billion or more in AUM. Notably, seven of the nine owe their success to in-house investments.
USMC-US, Principal U.S. Mega-Cap Multi-Factor Index ETF, is a perfect example. As of September 30, 2018, 85.47% of all fund shares were held by Principal Global Investors, which manages Principal’s Strategic Asset Management Suite.
Of the two non-issuer-owned ETFs that garnered $1 billion or more, only JPST is a natural success, with funds coming in from a variety of unaffiliated investors. The other, XLC, is more of a me-too product.
XLC-US, the Communication Services Select Sector SPDR Fund, was born from the 2018 GICS reorganization that carved out a new sector. Because XLC drew from both the technology and consumer discretionary sectors, SSGA could not simply spin it off as they did with the Real Estate Select Sector SPDR Fund in the previous GICS re-organization. XLC is the 11th Select Sector SPDR.
The next tier of 2018 ETF launches, amassing between $500 million and $1 billion (depicted in dark green in the above chart), told the same story. Funds like the Hartford Total Return Bond ETF (HTRB-US) owed their livelihood to parent company-driven investments. The Hartford Checks & Balances mutual fund held 11,051,000 of HTRB’s 11,600,000 shares as of November 30, 2018.
The next tier down – funds with assets between $100 million and $500 million, corresponding to the light green columns in the chart above – split evenly between funds that organically captured market share, and those that have been supported by a parent company.
The days of blockbuster launches that appeal to a wide swath of independent investors seem to be behind us. There has not been a TOTL (SPDR DoubleLine Total Return Tactical ETF), FV (First Trust Dorsey Wright Focus 5 ETF), or HACK (ETFMG Prime Cyber Security ETF) for four years. The gates to opportunity in the ETF industry are beginning to rust shut to all but those with in-house assets to cannibalize.
The bottom line is that over the past decade and especially during the past few years, the prospects for launching successful new ETFs dimmed significantly, except for those able to redirect in-house assets to these newer, and likely cheaper, products.