Are there too many ETF’s? No, there are not …
I hear it all the time, investors complaining about the overwhelming number of ETF’s that are available on the markets. Yes, I admit, there are many, and it can become confusing as for one index, there can be 5 or 6 ETF’s, and sometimes many more. I would say that it is still fairly easy to decide which ETF you should invest in. Simply follow the 6 rules of how to choose an ETF
But the more important issue here is that investors should be happy about having so many companies competing for their money. This has a major impact on fees that companies can charge and in the end the investors come out on top. I do believe that in the end, there will not be as many companies offering ETF’s. It is a much more difficult business than most companies realize.
To be certain, it is an attractive business. Imagine running a business that requires little maintenance and that can generate .20% of assets… that is as good as it gets. For example, Ishares has about $37 billions outstanding on EEM, and charges .72% of annual fees. That represents over $260,000,000. Now yes, of course there are costs involved. But you would think that the business is still able to pull in a good amount of profits every year.
And so companies all around the world have been thinking about ways to get into the game. Of course, it is a lot trickier than most people can imagine.
First off, to make an ETF attractive, you need to make it:
-Cheap: Obviously, one of the more important aspects is the annual fee. The lower it is, the better the chances of attracting funds
-High volume: Attracting investors requires having a liquid, high volume stock that will give investors the possibility of trading without excessive costs
That leaves companies with the challenge of creating an ETF that can become big enough to be profitable. Generally, they will need an ETF that:
-Differentiates from existing ones: The ETF must either track something new, a new index or in a new way. If it doesn’t, then it must offer something better than existing ones, usually lower fees
-Is popular: Yes, you read me right. Popularity is hugely important. If investors are looking for liquid and high volume stocks, how will they ever start investing in a new ETF that has no volume or active traders? It is a vicious circle and there are a few ways to get around it, but it is the most expensive and most overlooked part of the business:
-There has to be some institutional investors that trade the name or at least offer fairly thin bid-ask spreads
-There must be some marketing done to get more investors trading
Both of these end up being very expensive but they are necessary expenses until you have enough buyers and sellers every day to insure tight spreads and high volumes. Once that happens, the company can work on getting more flows that will result in more fees and more profits. It seems very simple, but actually the majority of ETF’s never reach that point and will end either closing or being unprofitable for years….
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