ETFs as a case study in disruption

ETFs as a case study in disruption

The exchange traded fund market is rapidly expanding and is projected to reach US$10 trillion by 2020, driven by cost savings, transparency, regulation and liquidity, writes Rob Rushe, who is EMEA ETF executive at BNY Mellon.. There has long been talk of exchange traded funds (ETFs) making mutual funds redundant, especially as ETFs continue to move beyond the passive space into active and alternative investments, but this is an overly simplistic way of viewing the changes taking place. The disruptive technology behind ETFs is changing the whole investment landscape, and with it blurring the lines between the different investment structures and distribution channels. ETF technology will continue to drive structural changes across the investment management industry for the foreseeable future.

Embracing any new disruptive technology is difficult, especially when doing so goes against a demonstrably successful business strategy. Indeed, even for those at the forefront of the disruptive movement such as Google, it is not always easy. In the early 2000s we were at the beginning of the era of mobile devices. Google, a company that derived the majority of its revenue through online advertising, was at a fork in the road. Should it try to keep people focused on desktop products, with their large amount of advertising real-estate? Or should it embrace mobile devices – which by contrast offer little advertising space – and so knowingly cannibalise a portion of its revenue?

With the benefit of hindsight the choice seems obvious. Google recognised it needed to be where consumers were heading and it built a new business model to ensure it did. There is no doubt it was a difficult decision given the potential negative impact to its existing business model. The natural position is to rely on what you have always done; the tried and tested path to success. But relying on the tried and tested approach is exactly what disrupters count on. Their success is driven by the lack of response from incumbents, who are often paralysed by a focus on currently stable – but ultimately unsustainable – revenue streams and the unwillingness of leadership to take action. Often when the action does come, it is too little too late. At that point the incumbents find themselves in a battle to survive.

Looking across the ETF landscape today, there are a number of similarities between today’s asset managers and Google in the 2000s. Just as mobile devices changed the way people accessed information, the distribution technology of an ETF is redefining how investors access the markets.

For an asset manager, the decision to move into the ETF space can be a difficult one. It could bring additional cost, require allocation of valuable capital and potentially impact some higher revenue generating products. However, an important distinction needs to be made. An ETF is not a new type of asset class or product. In its most basic form, an ETF is a technology, a new distribution channel and one that can be utilised by almost any mutual fund product today. The ETF business case does not support setting up a new standalone business unit. In fact, success is likely to come from how well it integrates into an existing business.

To date, ETFs have been seen as a challenger to the traditional mutual fund industry. For those asset managers who choose to bury their heads in the sand, it can and will be a challenge. However, when ETF technology is embraced it can be a very powerful tool to protect and grow an asset management business.

It is still early days, but there is no doubt that ETFs will go down as another case study in the disruptors’ handbook. The question for all asset managers is: will you be forced to react in the future, or will you act now?

The views expressed herein are those of the author only and may not reflect the views of BNY Mellon. This does not constitute investment advice, or any other business, tax or legal advice, and should not be relied upon as such.