On October 1st, 1908 Henry Ford introduced the Model T to the world. The power of the Model T was that it democratized the automobile so the average working-class person could afford a car for the first time. The design was simple and efficient. For much of its early production, the Model T was only produced in black. Future advances came from offering differentiation to meet the needs of different consumers. Eventually, competition entered the market, segmentation went wild, and now we have an automobile industry that delivers a wide variety of vehicle solutions. Competition in the ETF industry has democratized investing in a similar way. Early production was focused on being simple and efficient. Similar to the black Model T, early ETFs were mainly produced in one style: Market Cap Weighted. As ETFs have become a more widely used tool for investors, more differentiated and advanced strategies have been brought to market in response to a combination of investor demand and ETF issuer innovation. And the 80/20 rule is alive and well in the ETF industry as well–80% of the market is controlled by iShares, Vanguard, and State Street — but 20% is controlled by boutiques that deliver value propositions that target a specific niche. In a previous post, we looked at the history of the product development of ETFs from a high level; there have been two definitive waves: Market cap weighted ETFs and smart beta ETFs. In this post, we’ll focus on how we moved beyond the Model T of the ETF industry. I’ve broken the ETF universe into smaller categories to answer the following:
- Which product types have resonated with investor dollars to cause the growth of ETF product development; also, when did this occur?
- Ascertain the “why” behind the growth of ETF product development.
- What this tells about the future growth of ETF Product Development.
Rules for categorizing ETFs:ETFs are categorized as follows:
- Market Cap Weighted
- Leveraged and Inverse
- Low volatility
- The Pie Chart (on the left) represents the breakdown of the percentage (%) of AUM by product type.
- The Bar Chart (on the right) represents the breakdown of the number (N) of ETFs by product type.
2005: Beta to the World
AUM within Top 100 Equity ETFs by Product Category – 2005 (left) and Number of Product Category within Top 100 Equity ETFs – 2005 (right)In 2005, from both a percentage of AUM and the number of products in the top 100, it was the same story: market cap weighted products dominated. 81 of the top 100 names were broad-based market cap weighted funds (countries or regions) or sector funds that were market cap weighted. It’s not until you reach Guggenheim’s Equal Weighted S&P 500 fund (RSP) at number 26 on the AUM rankings, that anything but a market cap weighted fund comes up. That fund had just over $1.3 billion in AUM at the time. Growth and value ETFs also had a significant amount of the percentages, at a combined 9% of AUM and 14% of product type. Alternative product types made up a combined 2% of AUM and 5% of product type.
2008: A Second Tool Levers UpBy 2008, broad-based market cap weighted ETFs lost ground to other types of ETFs, dropping from 90% of ETF AUM in 2005, to 83% in 2008. Leverage ETFs came into the ETF world and again gave a new tool to investors. In 2005, investors of any type were able to achieve quick, easy, exposure to beta from around the world. With the market crashing and volatility up, investors were hungry for anything that could assist them in hedging that risk. Leveraged and inverse ETFs provided regular (and advanced) investors just that. In 2005, no leverage ETFs made it into the top 100 (as none were created yet!). At the end of December 2008, leveraged and inverse ETFs made up 5% of the top 100 equity ETF AUM and 13% of the product type.
2011: The Hunt for Yield and Low VolatilityIn 2008, dividend ETFs made up only 1% of the AUM, but 6% of the product type within the top 100 equity ETFs. In 2011, the total AUM of dividend ETFs began to catch up with the total number of dividend ETFs in top 100, as they now made up for 5% of the AUM. Investors needed income in the low-interest rate environment, and ETF issuers were happy to step in and provide them just that. With the two epic stock market collapses of 1999 and 2008/’09 still fresh in their minds (and stock market prognosticators consistently calling for more crashes to come), investors were also in search of something to calm their fears on that.For ETFs, one key to growing the AUM in a fund is an ability to explain the benefit in one sentence. A one-sentence explanation of the benefits make it simple for the financial advisor to explain to their end client, and that gives the potential of a rapid adoption. SPY? You own the 500 largest companies in America. VIG? It gives you a consistently growing income. IShares Russell 1000 Growth (IWF)? It gives you access to the fastest growing companies in America. In 2011, we saw the addition of a new one-sentence product type that resonated with investors at that time (and continues to do so today). On May 5 of that year, PowerShares launched the PowerShares S&P 500 Low Volatility ETF (SPLV). By December 31st of that year, the fund had already amassed an impressive $865 million in assets under management. For investors, “you get the S&P 500, with less volatility” was (and is!) a very attractive selling point. Now we had eight major product types (up from seven in 2005).
2014: Dollar Strength Flexes on ETFs2014 was the year of the dollar. It marked the first time since the turn of the century that the dollar rose against all major currencies. Simultaneously, international markets in Europe and Japan were rising. Investors started asking the following question:
If only there was a way I could own the international markets, and short their currencies.Enter WisdomTree. By the end of 2014, the Wisdomtree Europe Hedged Equity Fund (HEDJ) amassed $5.6 billion in AUM, putting it at number 37 on the top 100 list of large-cap equity ETFs. HEDJ went on to become the largest European Equity ETF in the U.S. in 2015. The trend faded somewhat, but the ETF industry once again gave investors of all types simple access to an advanced strategy. This brought the total to nine types of product types in the top 100 large cap equity ETFs.