ETFs are the smartphone apps of the investing world. It's hard to imagine how we used to get by without them. They are remarkably cheap to create and own. A small handful of the most popular ones dominate usage. There are new ones arriving weekly targeting every narrow interest. And there are far, far too many of them.
In a bit more than 20 years, exchange-traded funds have gone from an innovation no one was asking for ("Why would anyone want to trade a mutual fund in the middle of the day?") to the dominant new-product category in retail investment management.
Because of their structure allowing brokerage firms to create and redeem ETF shares without trading the underlying securities, they are inexpensive to own and tax-efficient. This gives them a dual nature for investors, the way light to physicists is both particle and wave: a highly efficient trading instrument that's also ideal as an inexpensive portfolio to hold forever.
This has made ETFs the one growth area in asset management, at the expense of traditional mutual funds, which are valued and change hands once a day, after the markets close. There are some 1,700 ETFs now listed, with assets under management of $2.4 trillion.
Yet even that isn't enough to go around, given how concentrated the assets are in a few funds and firms. The 10 largest ETFs – dominated by broad index vehicles such as the original SPDR S&P 500 (SPY) and Vanguard Total Stock Market (VTI) – command more than a quarter of all ETF assets.
And the four top firms in the business – BlackRock, Vanguard, State Street and Invesco PowerShares – oversee about 80 percent of that $2.4 trillion in industry ETF assets.
This is a tough equation facing the industry, given the relentless downward pressure on ETF fees, from already low levels.
For a representative glimpse of the daunting economics of this business, consider two large funds that are almost the same size, around $75 billion: BlackRock's iShares Core S&P 500 (IVV) and Fidelity Contrafund (FCNTX), a well-performing actively managed fund. The iShares fund charges just four basis points, or 0.04%, in total fees, or $30 million on its $75 billion in assets. Contrafund charges 71 basis points – pretty reasonable for an active fund with a big research team trying to beat the market. Total fees on Contrafund's present asset base are a lush $540 million.
Steve Sachs, who runs the ETF business at Goldman Sachs Asset Management, told us on CNBC Closing Bell this month that management fees on "straight beta" ETFs – pure index funds – are on "the long road to zero," even if they don't vanish entirely.