The Future of ETFs: An Advanced Investor’s Guide

Exchange-traded funds (ETFs) can be a simple, cost-effective approach to investing that provides diversification with a single, convenient, and easy purchase.

As of September 2023, the U.S. ETF industry had grown to $7.3 trillion from $4.3 trillion in pre-pandemic years, aided by the 2019 rule passed by the SEC to expand competition in the marketplace.

This is good news for investors looking to enhance their ETF portfolios and suggests further growth in assets as well as the number of ETFs. But where exactly is the ETF market headed in the future, and what are the trends investors should watch out for?

Key Takeaways

• An ETF is a security that invests its pooled funds in securities to track a benchmark, such as an index or sector.
• ETFs offer diversification and are a cost-effective approach to investing.
• In 2023, the U.S. domestic ETF market was about $7.3 trillion.
• By the end of August 2023, there were 9,904 ETFs worldwide.
• Trends indicate continued, future growth in investor interest in ETFs, new ETF launches, and capital inflows.

What Is an Exchange-Traded Fund?

An exchange-traded fund (ETF) is an investment vehicle that invests its funds in the same securities found in a particular benchmark index, sector, or other assets. By doing so, the ETF aims to track the return of that benchmark.

Features

• ETFs are like mutual funds in that they provide an investor with broad exposure to a variety of assets. For example, an investor may invest in a single technology ETF to gain exposure to many technology stocks.
• ETFs are passive investments when they track a benchmark. This means minimum transaction expenses and greater affordability than other investment funds, such as certain mutual funds and actively managed ETFs.
• In addition, they typically have low expense ratios.
• Popular ETFs are liquid securities, which makes them easy to convert to cash and diminishes the hidden cost of a wide bid-ask spread.
• ETFs trade intraday like stocks on an exchange. Investors can buy and sell them at any time during exchange hours. That’s different from mutual funds, which have specific rules and requirements regarding selling and are priced only at the end of the trading day.

Note

Various large, reputable financial institutions offer ETFs. Some of the most well-known are Vanguard, Schwab, Invesco, State Street Global Advisors, and BlackRock. Some popular ETF brands and products include iShares, ProShares, QQQ, and SPDR (which tracks the S&P 500 Index).

Where ETFs Are Headed

Since their introduction in 1993, ETFs have captured the interest and assets of investors. Retail and institutional investors have embraced the concept that asset allocation can result in better returns than those offered by individual security purchases.

According to asset manager BlackRock, ETF growth in 2023 reflects investment trends that support index investments as a primary strategy.

Index investing also continues to gain popularity as investors realize that the higher costs associated with individual stock investing erode long-term returns.

Additionally, as investors become active traders of their portfolios and wary of unnecessary advisory fees, low-cost index products such as stock and bond EFTs will gain additional traction.

New types of ETFs have also sparked intense interest in ETF investing. For example, on Jan. 11, 2024, spot bitcoin ETFs started trading in the U.S., having been approved by the U.S. Securities and Exchange Commission.

On May 23, 2024, the SEC approved the applications from the YSE, CBOE, and Nasdaq to list spot ether ETFs. This is generally considered to be a first step towards listing the actual spot ETFs on US exchanges. The actual issuers of spot ether ETFs now have to seek approval to be able to list them on the exchanges.

Growth in AUM and ETF Types

A PwC survey of global ETF executives indicates that global ETF assets under management (AUM) will reach a minimum of $18 trillion by 2026, and more likely, $20 trillion. It bases this outlook on the remarkable inflows of funds to ETFs, the new players entering the market, and the innovative products both in use and envisioned.

The survey points to crypto ETFs, thematic ETFs, commodity ETFs, and active ETFs as products that may satisfy the growing investor demand for new investment opportunities. Of the 543 new ETFs that launched in 2023, Morningstar found that approximately 75% of them were actively managed.

The Future of Asset Management

Asset managers, such as those that offer ETFs, have the opportunity to improve the way they do business, the quality of products offered to investors, and their financial results with emerging technology innovations.

AI and Risk Management

A 2023 report from EY (Ernst & Young Global Limited) suggests that financial firms may face hurdles without integrating more digitization and the use of artificial intelligence (AI).

AI technology can help fund managers improve the way they conduct their operations and interact with clients.

Additionally, asset managers who focus on risk management techniques combined with a high level of transparency will profit most.

Are ETFs Long-Term or Short-Term Investments?

ETFs can be long-term or short-term investments depending on the investor’s time horizon and investment style. Those looking to invest and hold long-term may choose an ETF that invests primarily in blue-chip firms. Short-term investors may choose an ETF that invests in new startups that have high growth potential for the near future. Or they may prefer to trade ETFs with some frequency to actively manage their portfolios.

How Many ETFs Are There Globally?

At the end of August 2023, there were 9,904 ETFs globally. This is an increase from 729 in 2006 and 6,952 in 2019.

What Are Some Risks Associated With ETFs?

Like other investments, ETFs have market risk since their success relies on the gains of their underlying assets. ETFs may experience a shutdown when the fund is liquidated. Investors will lose their investment vehicle but will be paid in cash.

The Bottom Line

ETFs have experienced significant growth since their introduction in 1993. They have proven an attractive option for investors looking to diversify their portfolios easily and at low cost, without increasing the time and effort they spend managing their assets.