The landscape of fund trading on exchanges is poised for a significant change with a wave of new product introductions. The fund sector, having experienced substantial growth over the years, could potentially double its market footprint.
This shift largely stems from recent adjustments by the Securities and Exchange Commission that now permit traditional mutual fund managers to offer ETF share classes for their existing funds.
To give you some perspective, there are currently approximately 4,000 ETFs available. That’s a pretty staggering figure, and as financial futurist and ETF expert Dave Nadig mentioned on the ETF Edge podcast this week, ETFs are where much of the action unfolds.
Interestingly, Nadig anticipates that the number of ETFs could surpass 7,000 in just a month, with projections hinting at the launch of up to 3,000 more as mutual fund managers create ETF share classes, pending SEC approval.
“We are looking at a massive wave of products,” Nadig stated.
This year alone, around 400 new ETFs have been launched without changing their share classes. From single-subscription ETFs to those designed to generate innovative income without exposing investors to high stock risks, it seems the situation is only going to intensify. “You’ll need to research what’s available now more than ever,” Nadig advised.
Nadig estimates that about 53 mutual fund companies have submitted applications for ETF share classes, which means the surge of new offerings may create considerable challenges for individual investors and advisors trying to navigate the options.
The appeal of ETFs is undeniable, and for good reasons: they offer daily trading, liquidity across major asset classes, relatively low fees, and tax-efficient transactions. This year alone, more than $400 billion has flowed into ETFs. It’s worth mentioning that despite the growing complexity of ETFs, many transactions are still tied to the core market, including alternative funds and portfolios with options designed to mitigate volatility.
Vanguard Group’s S&P 500 ETF has set the pace to break trading records due to the annual inflows that surpassed last year’s figures.
Nadig reminds us to be prepared for the upcoming swell of ETFs. “Most of these upcoming products will be rather conventional,” he clarified. For instance, large growth and core equity funds from mutual fund companies have been employing similar strategies for a considerable time. “These are largely traditional asset allocation products,” he noted, mentioning that they haven’t ventured into significantly new asset classes like crypto or private credit.
However, there are reasons for investor skepticism. The mutual fund industry has a history where active managers often fail to outperform benchmarks, which has contributed to a “pretty expensive” legacy, as Nadig put it.
On the bright side, the ETF share class model allows for a strategy to be offered at the lowest institutional fee level from these managers. Nadig emphasized that keeping the historical performance of active management in mind is crucial. “If you want to access these firms’ products, this is the most efficient route,” he mentioned.
Nadig adds that the approach to new strategies remains cautious, highlighting that investors are taking their time to adopt them. For instance, private credit has garnered substantial interest since the debut of the first ETF in that asset class. However, its launch has met with notable friction. State Street and Apollo Global Management collaborated this year on their initial private credit ETF under the ticker symbol Priv, but demand has been tepid, attracting roughly $54 million from investors thus far.
“I don’t see a significant appetite for private credit, though there’s a surplus in supply,” he remarked.
The launch of Priv has been a unique occurrence, albeit not quite aligned with the SEC’s intentions. So far, trading volumes for it have been minimal, around “thousands of dollars a day.” Nadig noted, “It’s clearly been declining,” suggesting that investors might view it as just another high-cost bond alternative.
Nonetheless, Nadig pointed to emerging asset classes with new risks that may have greater appeal to retail investors. Take ETFs that give access to private companies like SpaceX and Klarna, as seen with the XOVR—an ETF targeting private-public crossover investments. It’s essential to realize, however, that even ETFs like XOVR primarily hold publicly traded stocks, with limitations on investments in illiquid securities. Interestingly, SpaceX holds only about 0.5% of the fund, while Klarna constitutes nearly 10%, making it a significant player within the $300 million fund.
“There’s genuine interest there,” Nadig said. “I believe private equity attracts real retail cash,” he added.
Still, with more complex trading strategies, investors should consider two critical questions: Is the ETF structure truly appropriate for this investment concept? For many illiquid securities, it might make more sense to use interval funds or closed-end funds. Nadig pointed out that the SEC has indicated a desire to enhance retail access to closed-end funds and other private investments.
“It’s a valid move to guide investors towards vehicles with lower liquidity,” Nadig argued.
Moreover, market illiquidity and niche sectors can create capacity constraints. As funds grow, managers might struggle to find securities to fulfill their commitments, potentially facing trading stress during market volatility. If investors rush to exit during a credit crisis, and if managers hold a substantial amount of illiquid assets, the ETF structure may face challenges, too. Nadig explained, “You can’t shut down the fund or the ETF; during such times, you’ll witness wild trading patterns with significant price fluctuations.”
In conclusion, as more traditional asset classes enter the ETF marketplace, investors will encounter the ongoing dilemma of whether active managers deliver desired results. “It’s really about the challenge of merging illiquid investments into a structure meant for high-frequency trading,” Nadig noted.
