If you have been a reader for any sustained period of time, you know my views on the growing dominance of ETF & computer based trading. Rather than buying individual stocks, much of the fast institutional money sweeps into ETFs and hence individual stock analysis has become a lot less relevant as every stock within an ETF gets bought or sold, if that is the flavor of the day. This is especially true in the commodity space - hence why almost always all the coal stocks move en masse, or all the natural gas stocks, or all the gold stocks. We see the same phenomenon in other sectors (financials, technology, et al) - and I think those who are ignoring this trend are not understanding the changing the landscape.

The Wall Street Journal posted a story about how the ETF growth is potentially going to reach a point of surpassing mutual funds. I think eventually this could happen but it really is 2 different audiences - most passive investors, aside from buying a broad index ETF are not going to be interested in 90% of the ETF products out there; they are geared more to the active trader or someone who wants specific niches. The other issue with ETFs are so many products - if you look at the volume on many ETFs they trade less than many small cap stocks. How many home builder ETF stocks do we need in a space with a dozen builders? How many coal ETFs will we need? etc. Last, some of the sub niches in the ETF world are way over the top - for example did you ever hear of WSI? I hope not - it was the FocusShares ISE-Revere Wal-Mart Supplier Index Fund (WSI). Thankfully it was taken behind the barn and shot. Many others are of similar ilk. That said, there is a case for many mutual funds to be blindfolded and handed a cigarette as well...

I continue to believe the long only, cash is trash, always bet the markets go up buy and hold forever model of mutual funds will continue to be challenged in the years to come. An industry with reached great heights in a once in a lifetime bull of 83-99 has not fared well since, and would not of fared well before 1983. [Feb 5, 2009: Mutual Funds Have Tough Decade]

  • Exchange-traded funds pose a growing threat to the entrenched supremacy of mutual funds as more investors are drawn to these low-cost, passively managed vehicles, analysts say.
  • Mutual funds have a 69-year head start on ETFs and it is unlikely that ETFs will become bigger in terms of net assets anytime in the near to medium term, he wrote. However, ETFs will increase their share of investment dollars as more investors find them to be an attractive option.
  • Assets in U.S.-listed ETFs climbed to an all-time high of $607 billion at the end of August, according to research from Barclays Global Investors. There were more than 700 ETFs, not including exchange-traded notes, their close siblings. (much like in the mutual fund world I'd assume that 10% of those ETFs - or 70 - own 80%+ of the assets; way too much me too product in both industries)
  • Based on a conservative growth rate of 20% compounded annually, Stier said ETF assets will top $1 trillion by mid-2011. The U.S. mutual-fund business controls roughly $10 trillion.
  • Brad Hintz, an analyst at Bernstein Research, in a Sept. 23 research note said the growth of passive index products in general and ETFs in particular represent a threat to traditional asset managers. He expects investors will focus even more on fees with a sluggish outlook for stock and bond returns after the financial crisis. Tax efficiency is another selling point for ETFs.
  • Deloitte's Stier, in an interview, said financial advisers and investors have also been drawn to ETFs' transparency during the market turmoil of the past year. ETFs are baskets of securities, such as equities or bonds, that trade on exchanges like individual stocks. Their holdings are disclosed throughout the trading day. (catch 22 for fund managers - the industry is rife with lagged transparency, BUT how open do you want to be if you have a good strategy that you don't want to be copied?)
  • ETFs have exploded in popularity since they first hit the U.S. market in the early 1990s, although the business has experienced growing pains and been accused of fostering a bubble mentality in terms of product launches.

  • Although there are dozens of ETF managers, the industry is really dominated by three players: State Street Global Advisors, Vanguard Group and Barclays Global Investors, which is being acquired by investment manager BlackRock Inc. (BLK).
  • There has been a strong first-mover advantage in ETFs, with most of the assets concentrated in a handful of huge funds such as SPDR S&P 500 ETF (SPY), iShares MSCI Emerging Markets Index Fund (EEM), SPDR Gold Trust (GLD) and PowerShares QQQ Trust (QQQQ).
  • In early September, 10 ETFs accounted for more than 60% of the daily trading volume, according to Morgan Stanley, while 120 ETFs had less than $10 million in assets.
  • Yet dozens of ETFs have closed due to lack of interest and some firms have been forced out of the business, which has experienced some hiccups lately. Regulators have been turning up the heat on leveraged and inverse ETFs on fears investors may not understand these complex funds.
  • Meanwhile, some commodity ETFs and ETNs have been roiled by expectations the U.S. Commodity Futures Trading Commission may crack down on the size of their positions in derivatives markets. (maybe if the regulators did not unleash every Tom, Dick, and Harry ETF into the marketplace before studying how they'd actually work, we'd have less of these issues - but I suppose that would take work)

And here is where the true bread is buttered in the asset management business; now dominated by just a handful of mutual fund families.

  • Efforts to break into the huge retirement-plan market are another wild card for the business, which is trying to make ETFs more friendly to the 401(k) industry, Stier said. As more traditional asset managers enter the ETF business, they could use their influence and relationships to bring ETFs to more retirement plans.

[Apr 17, 2009: Decade of Losses, Forces Investors in their 30s to Start Over]

[Oct 7, 2008: 2000s Stock Market Worse than 1930s]

[Mar 26, 2008 - WSJ: Stocks Tarnished by Lost Decade]