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Capital Markets

Consolidation: the next step for ETFs?

There are a host of ETFs that investors can pick and choose from, but some experts believe consolidation will be the next stage

Experts say the boom in the number of exchange-traded funds (ETFs) will stop and the funds will face mass consolidation, despite the industry clocking an annual average growth of 40% for the past 10 years.

“ETFs have been popping up like mushrooms,” says Justin Urquhart Stewart, co-founder and marketing director of 7im. "Can they continue like this? No."

One prediction by analysts is that in the near future there will be a consolidation in ETFs, with the glut of small funds currently present growing in size but shrinking in number. 

While investors may like the idea of a high number of funds, as they offer exposure to potentially niche areas, there is concern that the market may not be able to support current ETFs.

“We’re going to see consolidation in the market, as there are just too many small providers at the moment,"  says Steve Doran, fund manager at HSBC Global Asset Management. "There’s a rationale for having a broad range of tools, but there are too many providers for the market to support. However, the fragmentation of European markets has historically presented a barrier to large-scale consolidation in Europe – with cross-border consolidation far more difficult than integration within a single country."

Jose Garcia-Zarate, ETF analyst at Morningstar, adds: “The fragmentation in Europe will make consolidation difficult. While Credit Suisse and UBS may be big players in Switzerland, I’m not sure how big they are in – say – France.” 

The abundance of ETFs in Europe might be a reaction to the high appetite for ETFs in the US in the years following their inception. Seeing this high demand, European seeders acted in the expectation of similar demand in Europe.

“There are a lot of products in Europe at the moment,” says Scott Ebner, global head of ETF product development at SPDR. "The providers benefited from the US experience and anticipated high demand: the number of funds has been a little bit ahead of their time."

Much of the debate has been on the distinction between synthetic and physical ETFs. Synthetic ETFs have been the subject of much concern, particularly their suitability for retail clients, given their complicated nature.

Synthetic ETFs have mainly been put out by investment banks, and with regulatory scrutiny increasing on the product, it is possible there might be a shift in where ETFs originate. Regulatory tightening on synthetic ETFs might have the unintended effect of dissuading investment banks from participating in the ETF market.

“Investment banks tend to focus on synthetic ETFs and asset managers on physical ETFs,” says Garcia-Zarate. "Whether investment banks continue to stay in the ETF business will depend on what the regulators have to say on synthetic ETFs."

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