Global assets held by exchange traded funds have climbed to a record $6tn, doubling in size in less than four years, in a surge turbocharged by the lengthy US stock market bull run.
The sector’s explosive growth has attracted heightened scrutiny by regulators who are concerned about the influence of ETFs as they spread deeper and wider into financial markets worldwide.
“Passing the $6tn milestone is a historic moment but we are still in a relatively early stage of the industry’s development as ETF adoption rates across Europe and Asia are well below those seen in the US,” said Deborah Fuhr, co-founder of ETFGI, a consultancy.
ETFs, which provide a low-cost way to invest in a basket of assets by tracking an index, were seen as an insignificant niche before the financial crisis. But the failure of most traditional active managers to avoid damaging losses during the crisis prompted many investors to seek less volatile strategies built with ETFs. These financial instruments have gathered more than $3.5tn in new cash over the past decade.
Inigo Fraser-Jenkins, a senior analyst at the brokerage Bernstein, said the penetration of index-tracking ETFs into financial markets still has “a lot further to go”.
“Allocation decisions to passive [index funds including ETFs] don’t appear to be slowing at all,” said Mr Fraser-Jenkins.
Global ETF assets could reach $12tn by the end of 2023, according to BlackRock.
The rise of ETFs has helped BlackRock and Vanguard, the pioneer of index-tracking funds, to develop into the asset management industry’s two biggest and most influential players.
BlackRock’s iShares ETF arm has attracted at least $125bn in new cash so far this year, pushing the unit’s assets above the $2tn mark in October. Rapid growth for iShares has propelled BlackRock’s total assets to a record $7tn.
ETFs inflows have helped Pennsylvania-based Vanguard to retain the title of world’s fastest-growing fund manager for seven consecutive years. Vanguard’s ETF arm has gathered at least $88bn in new cash this year, lifting its total assets to $5.9tn.
The rivals have led a cut-throat price war on fees which has sucked in smaller competitors including State Street, Charles Schwab, DWS, Lyxor, UBS and Amundi. The battle has created unrelenting pressures on profit margins across the fund industry and forced greater consolidation.
After a record year for deals in 2018, more mergers and acquisitions are widely anticipated as smaller players attempt to reconfigure their business models to better withstand the competitive pressures exerted by BlackRock and Vanguard.
ETFs now regularly account for a third of the trading on the US stock market and an even larger share in periods of high volatility.
Growth in the number of shares held by ETFs has reduced the availability of stocks for trading for other market participants, according to Bank of America Merrill Lynch.
A recent Goldman Sachs study concluded that ETF trading is influencing the volatility of underlying stocks. Some academics also believe that ETFs flows are distorting the US stock market’s critical price discovery function, which could lead to the misallocation of capital and eventual damage to economic growth.
These issues have led to greater scrutiny by regulators who remain concerned that potential risks associated with ETFs are understated by their managers and not fully appreciated by less sophisticated investors.
Regulators know that the vast asset purchase programmes introduced by central banks after the financial crisis have helped drive US stocks to all-time highs and created potentially dangerous price bubbles in bond markets.
Uncertainty over whether orderly trading might be disrupted by large scale selling by ETFs in a market correction, leading to a destabilising downward spiral and bigger losses for investors, remains a troubling unknown in the minds of many regulators.
“ETFs have undoubtedly lowered the cost of investing but there are unanswered questions about their impact on the functioning of financial markets,” said Mr Fraser-Jenkins.