The exchange-traded fund industry has a revenue-generating potential of around $6bn per year in the US alone, according to Dave Nadig, director of ETFs at FactSet Research Systems.
iShares has the largest revenue-generating ETF suite of all US providers with $939.4bn in assets, generating $2.4bn in annual revenue. (Figures as of end of September 2016)
This figure has been approximated by adding the “annual revenue potential” of every US-listed ETF. Each fund’s annual revenue potential is estimated by multiplying the fund’s current assets under management by its total expense ratio.
By applying this calculation, the US ETF industry has an estimated annual revenue potential of $6.043bn as of the end of September 2016. With $2.4tn in assets under management, this translates as a 0.25% weighted average expense ratio per US-listed ETF.
Nadig believes the industry will continue to see fee reductions on core products as providers attempt to gain new money in a competitive marketplace, counting on economies of scale to secure profits via a product suite of mostly cheap, plain equity ETFs. Other ETF providers may focus on more expensive, niche products such as smart beta funds to make revenue.
For example, iShares in the US just cut fees in October for 15 of its funds by between 2 and 5 basis points. The iShares Core S&P 500 ETF (NYSE ARCA: IVV) has become the cheapest in the US market, falling from 0.07% to just 0.04% in fees.
Even though FactSet estimates that BlackRock is set to lose about $74m from the price-cuts, it would still be well ahead of its competitors in terms of revenue generating potential.
The data shows that BlackRock leads the way with $939.4bn in assets and $2.4bn in revenue generating potential. State Street Global Advisors is in second place with $455.5bn in assets and $878.0m in revenue generating potential. Vanguard, third on the list, has more than half the assets of iShares at $576.2bn yet, at $526.3m, it has less than a quarter of its revenue generating potential.
Providers with significantly lower total assets but higher-cost funds tended to list higher than most other larger, but cheaper, providers in terms of revenue generating potential. First Trust stands at number five on the list with just $39.6bn in assets but $271.0m in potential revenue, while low-cost provider Schwab falls to a lowly 17th place on the list.
The implementation of the new Department of Labour fiduciary rule, which mandates brokers to advise their clients to invest in products that they would pick for themselves, is expected to shift a greater proportion of future net inflows towards low cost providers. The new rule aims to help retirement investors, encourage brokers to operate with their clients’ best interests at heart and avoid conflicts of interest, but it still needs to be approved by congress before being implemented in 2018.
The ETF market is dominated by plain vanilla funds, representing more than $1.7tn in the US and generating $3.8bn in revenue, FactSet data shows.
More exotic and specialised products, such as single- and multi-factor funds, thematic ETFs, or currency-hedged products, make up the remaining 28% of assets. Despite consisting of a smaller piece of the asset pie, these funds generate a healthy $2.2bn in revenue. The relatively small gap in revenue between the two segments is partly explained by leverage and inverse ETFs that charge higher fees but still track so-called plain vanilla indices. As a result, providers like ProShares and Direxon feature on the top 10 list in terms of revenue generating potential.
As for the future of the ETF industry, Nadig predicted there will be a “bifurcation” of the market: a lot of assets in very cheap, plain vanilla ETFs which are “relatively unimportant” to their providers in terms of revenue, alongside a host of relatively expensive and niche ETFs, which are “enormously important to the bottom line”.