What’s driving growth in the ETF industry?

The ETF industry has evolved significantly in recent years, and we are now seeing several new investment strategies emerge in this space. We look to answer common questions on the trends driving the demand for ETFs globally and what the future looks like for this market.   

Q: How has the ETF industry developed globally in recent decades?

A: ETFs are a disruptive technology. The reality is that this industry is still relatively new and is just 30 years old. In 2023, the ETF industry surpassed US $11 trillion in assets globally with a 5-year compound annual growth rate of 19.3%.¹ In terms of the regional distribution of assets under management (AUM), the US and Canada comprised over US $8 trillion, Europe made up $1.8 trillion, and Asia Pacific accounted for $1.3 trillion of these assets (Figure 1). All regions have been experiencing double-digit growth despite starting at different places. For example, the US was very wealth-driven at inception and has become more institutional over time, with the growth of asset types like fixed income ETFs. Europe whilst starting out with the wealth segment, has become more institutionally led over time through discretionary asset management and is now moving toward retail via digital distribution channels. Asia has had a similar trajectory to Europe.  

Q: How do you expect the global ETF market to grow in the next five years?

A: The global ETF market is expected to continue growing rapidly, doubling roughly every four years. It is expected that ETF AUM globally will reach US $20 trillion approximately by 2028², although an acceleration in growth in specific markets could bring about this milestone earlier. We’re seeing growing demand across many parts of the Asia Pacific region such as Taiwan, South Korea, and Japan. The introduction of savings schemes in Japan, for example, is really accelerating growth.

Q: How are ETFs evolving in terms of usage and investment strategies globally?

A: An ETF is a wrapper; it is not an investment style. This is an important aspect for people to get comfortable with. The industry started with broad market cap-weighted indices, and the S&P 500 is a great example of that, with around US $1.4 trillion of the ETF market being benchmarked to this index.³ But the reality is that innovation in this space has been taking place over the past twenty to twenty-five years and encompasses various investment strategies beyond traditional market cap-weighted indices.

Alternative weightings like equal weight and the move towards active management has been gaining prominence in recent years. Gold is another example, while not an indexed product, currently around US $100 billion of AUM is in gold ETFs globally.⁴ We are seeing factors, smart beta, and thematic ETFs gaining ground. Fixed income ETFs are also experiencing significant growth across all regions, with around half of the forecasted growth by 2028 expected to come from this asset class.⁵

Q: Looking at active ETFs, what challenges and opportunities do these present for investors and asset managers?

A: Active ETFs are gaining popularity, particularly in the US market, due to tax efficiencies relative to mutual funds. In 2023 about 22% of new money coming into the US ETF market was in active products.⁶ However, transparency remains a key challenge as ETFs are completely transparent vehicles. Active asset managers therefore need to be comfortable with portfolio disclosures that are real-time.

Most of the active ETF growth on the equity side is being observed in benchmark-plus products which use active management to directionally slant the portfolio. We are also seeing interest in active fixed income products and by far the largest portion is in the short-duration cash part of the cycle. This also links to the digital distribution question, and we expect the ETF format to be the way forward to access digitally savvy clients. Integrating active ETFs into digital distribution channels is therefore crucial for future growth.

Q: Which technological advancements will shape the ETF industry in the next five years?

A: The next frontier in ETF technology may include increased customization capabilities and real-time pricing. Advancements such as blockchain may facilitate portfolio customization, while innovations in pricing mechanisms could enhance accessibility and liquidity for investors. For example, what we’re starting to see in Hong Kong in the brokerage platforms is US ETFs being priced to retail in Asia hours. Moreover, digital platforms and social media channels are likely to play a more significant role in ETF distribution and investor engagement.

Q: How can ETF providers address winner-takes-all dynamics in the ETF market?

A: Innovation and being first to market are critical in addressing the winner-takes-all dynamics in the ETF industry. Size and scale provide market-leading advantages, making it challenging for competitors to catch up. By focusing on innovation and staying ahead of the curve, ETF providers can maintain their market dominance and continue to drive growth. Additionally, collaboration and leveraging expertise across regions can further strengthen their market position.

With contributions from Monica Uttam, Thought Leadership and Insights, Asia Pacific

Investment risks

Investment involves risks. The value of investments, and any income from them, will fluctuate. This may partly be the result of changes in exchange rates. Investors may not get back the full amount invested.

There are risks involved with investing in Exchange-traded Funds (“ETFs”), including possible loss of money. Index-based ETFs are not actively managed, and the return of index-based ETFs may not match the return of the underlying index.  Actively managed ETFs do not necessarily seek to replicate the performance of a specific index. Both index-based and actively managed ETFs are subject to risks similar to those of stocks, including those related to short selling and margin maintenance requirements. Ordinary brokerage commissions apply.