Financial Services Ireland


Can ETFs scale new heights in the post Covid-19 world?

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While Covid-19 had obvious impacts on asset management in 2020, in terms of volatility and wider economic concerns, it did not alter some fundamental long term trends in the industry – not least the continued robust performance of ETFs. EY’s latest ETF research shows the success of ETF promoters’ growth plans, based on product innovation, retail adoption and digital distribution.EY’s Lisa Kealy, Wealth and Asset Management Sector Leader and Kieran Daly, Partner, Wealth and Asset Management, explore the findings for the December issue of Finance Dublin. 

Despite the challenges of Covid-19, the ETF industry continued to grow during 2020. The Financial Times reported that ETF assets reached US$7t of global assets under management (AUM) in August1 and data from the London Stock Exchange shows that trading volumes for exchange-traded products (ETPs) experienced record highs in March 20202.

That seems to confirm the conclusions of a Financial Conduct Authority (FCA) research note from 2019, which found that, despite concentration in primary fixed income ETF markets, stress events were unlikely to see liquidity evaporate3.

In short, ETFs appear to have come through this testing time strongly. EY’s latest research shows that ETFs’ performance in stressed conditions is seen as the greatest upside to emerge from Covid-19, and investors seem to agree – many individual ETFs enjoyed some of their strongest ever performances during April 2020.

Outlook and key challenges

The performance of ETFs during market stress is not the only factor that argues for continued AUM growth into the 2020s. The industry’s historic growth drivers, including the shift to passive and the structural decline of fees, remain in force. Other trends reshaping the investment industry – like the tendency of smart beta and factor investing to replace core active, the increasing demand for high standards of transparency, and the need for individuals to take more responsibility for long-term savings – should also favour ETFs.

This picture is backed up by EY’s latest ETF research, which shows that ETF participants expect the next five years to see a cumulative average growth rate (CAGR) in AUM of 15% for ETFs in Europe, with 11% in the US and Asia-Pacific. EY’s own predictions are slightly less bullish, reflecting the global outlook for asset management – which we expect to feature slowing growth in AUM, revenues and net inflows. Our forecasts, which incorporate the likelihood of further market corrections and a slow W-shaped recovery, anticipate a CAGR of 10% in AUM for European ETFs over the next five years and expect global ETF assets to reach US$10 trillion by 2025.

That would still be a remarkable achievement, but success cannot be taken for granted. The ETF industry faces growing challenges, too, including:

  • Political uncertainty: The importance of market access and cross-listings to the ETF ecosystem means that the industry is potentially sensitive to political risks. Brexit represents a particular challenge, but the uncertainties caused by Covid-19 and global geopolitical rivalry also raise questions over international growth.
  • Increasing competition: Rivalry among providers, slim margins and a steady flow of new entrants suggest that competition within the industry will only intensify. EY research shows that falling fees and margins are expected to be the leading challenges for ETF providers over the next three to five years. Profitability pressures also increase the risk that short-term cost cutting in areas, such as investor education, could harm the industry’s long-term growth prospects.
  • Product proliferation: Low margins mean that fund size is a crucial driver of ETF profitability — and yet, new products are seen as the leading source of growth. The result is that confidence in the success of fund launches has fallen from 57% in 2018 to 46%. The contradiction between the desire to launch new funds and the need for economies of scale will only become more acute as fees decline further.
  • Innovation risks: Developing innovative new ETFs is central to growth, and “winner takes all” dynamics makes speed to market essential. But regulatory attention resulting from new products is expected to be the industry’s number two challenge over the next three to five years. Reconciling rapid innovation with ever-growing stakeholder expectations for transparency, value and performance will be increasingly important during the 2020s.
Avenues for growth

So, what will drive the growth of ETF assets over the next five years? Experience suggests that flagship index-tracking funds will capture a large slice of inflows. But wafer-thin margins mean that this is not a sustainable growth of strategy for new entrants. Nor will it help the bulk of ETF providers. That view is confirmed by EY research, which shows that individual ETF promoters expect the key drivers of growth to be launching new products, reaching more investors and improving distribution networks. New entrants are also expected to drive the industry’s expansion. But none of these growth avenues will be straightforward.

The increasing scale, complexity and reach of ETFs, together with the ways in which Covid-19 is accelerating change in the investment industry, mean that it’s vital for all ETF providers to tailor their growth plans to the post-pandemic world. Delivering the right outcomes, to the right investors, in the right way, will be essential to the industry’s ability to achieve sustainable growth. EY believes the ETF industry must focus on four key areas during the years ahead if it is to reach its ambitious targets for expansion:

Navigating the risks and opportunities of regulation

EY research shows that ETF professionals (74%) see regulation as the leading driver of change in operating models. This is about more than short-term compliance. The fast-changing political environment has major implications for the industry’s plans for growth.

Needless to say, Brexit is the most urgent consideration for many ETF providers. Most are confident that they will be able to manage its associated risks, but the prospect of a “no-deal” outcome is still a major source of uncertainty given the UK’s status as Europe’s largest ETF market and as a portfolio management center for ETFs domiciled in Ireland or Luxembourg.

Getting sustainable investment right

Sustainable investing continues to grow rapidly around the world. ESG-themed ETFs were reported to have gathered. US$38b in new money during the first seven months of 2020, reaching US$100b in AUM for the first time. That followed the volatility of March 2020, when ESG-themed ETFs were found to have outperformed the wider market. Sustainable investment represents a particularly important opportunity for the ETF industry, given the increased focus on nonfinancial outcomes among all investor groups. EY’s ETF research shows that providers see ESG funds as the leading source of future growth and the key focus of product development. That includes funds with an ESG-themed overlay as well as thematic ETFs, especially those focused on climate change factors.

Even so, it would be a mistake to see ESG-themed ETFs as a one-way bet for promoters. Demand for sustainable investment may be growing fast, but so too are stakeholder expectations.

Rethinking customer journeys

Investors of all types increasingly demand solutions that let them achieve their long-term objectives, not just relative performance. All investment managers are under pressure to deliver a transparent investment approach tailored to clients’ financial needs — and their sustainability beliefs. This shift in behavior presents opportunities and challenges for ETF providers. On the upside, the growing depth of ETF offerings means that the industry can provide a full range of investment styles and strategies, including core passive, factor investing, thematic investing and active management. Set against that, the industry’s belief in the advantages of the ETF structure can make it hard to look beyond products and deliver compelling journeys oriented around investors.

Technology and data

ETF professionals expect investments in technology and data to help them enhance a range of core activities, including customer analysis (according to 71%), investment analysis (68%), product development (63%) and cost reduction (63%).

ETF promoters know that a strategic view of technology is crucial to developing scalable and sustainable business models. But real life and “winner takes all” dynamics often get in the way. Innovation is a key driver of inflows,? making speed to market a vital component of success. This can lead to a disconnection between the long-term investments that providers want to make and the need for ad-hoc investments to help bring new products to market or comply with new regulations.

Covid-19 has only made it more difficult for ETF firms to take a strategic view of technology and data. Resources have been diverted to enable remote working, and the physical dispersal of teams makes it harder to visualise and implement change — although altered ways of working could give firms access to new resource pools.

The road to 2025

Competition has always been strong in the ETF industry, and recent years have seen growing pressure on margins and profitability. Covid-19 has only strengthened these dynamics, making further downward pressure on fees and profitability seem inevitable.

Despite its success to date, the ETF industry needs to align its business models with the ‘new normal’ as it charts its route to 2025 and beyond. ETF providers that can develop and deliver an effective strategy for growth in the post-Covid world will be better placed than ever to create sustainable value for investors and society at large and, in the process, for themselves.

To explore these themes in full, download the research findings at

This article first appeared in Finance Dublin. Don’t hesitate to reach out if you have a question. 

Thought Leaders

Lisa Kealy

Financial Services Markets Leader

Kieran Daly

FS Partner, Assurance, Wealth and Asset Management