If the ETF world was suddenly the victim of leaked internal documents, what would they say? Watching CNN’s coverage of the WikiLeaks/U.S. military story made me think about this recently. Here are the four prominent headlines that might result: Pricing Angst, Tax Fears, True Third Party Support, and An Absent Industry Voice.
The internal documents on ETF WikiLeaks would reveal concern by ETF sponsors about the trend of cost cutting in the ETF world. Whether it was Vanguard or Schwab undercutting on broad based ETFs, iShares on Gold or the economics behind free ETF trading, there is beginning to be an economic race to the bottom. The documents would show that large legacy sponsors are frustrated in their declining profit margins on their flagship products but understand this trend is inevitable. On the flip side they would recognize that a larger economic moat around the ETF sponsor business is forming, which is ideal for them. Smaller sponsors, who tend to have less broad based products, would be less concerned about this trend although they would be concerned about being left out of many free trading programs. There would also be predictions that the next area to see further price competition is emerging market ETFs. These products reside at the higher end of the ETF expense ratio spectrum and have experienced an influx of assets, competitive products and sponsors. In 2011, the competition in this space will likely shift away from index methodology and become more focused on expense ratio.
Tax Advantage Fears
With news out of Washington that elements of the Zero Plan are receiving some traction, ETF WikiLeaks would report that many sponsors are nervous about the long term future of the ETF vehicle’s tax advantaged status. While this feature exits, ETFs have a distinct tax advantage over mutual funds. The thinking goes that if US tax law takes aim at the tax status of insurance contracts or pension plans, could ETFs be next? While the elimination of the tax advantaged status of ETFs would be a huge blow for the ETF industry, many would argue there are many other important features the vehicle brings to investors including cost efficiency, transparency and intraday liquidity. If anything, ETFs would be relegated to abide by plain old mutual fund tax rules, hardly a disaster for an industry still delivering on a variety of the aforementioned features. Still others would argue that the relatively small size of the ETF industry might allow it to fly under the radar of new tax legislation.
True Third Party Support
ETF WikiLeaks would likely show a growing discontent for Third Party support when it comes to ETFs. Many in the ETF crowd admit that the industry is disjointed in terms of education, information and analysis. This is stunting the growth of the industry. The mutual fund world has had Morningstar and Lipper to create solid third party standards and analysis. The ETF world has seen these firms retro fit content and ratings recently but the customization for ETFs is just not there. As Morningstar made its name by concentrating early resources on mutual funds and creating industry standards like the style box, there exists a new opportunity for a brand to embrace the ETF world by defining, organizing and analyzing it. The traditional mutual fund born players have too many legacy issues holding them back to devote the resources or unique expertise to this area. The investment public and the ETF industry is thus suffering because it is too cumbersome today to compare different sponsors’ ETFs in terms of structure, index methodology, tracking error and holdings for example. ETF WikiLeaks would capture many sponsors realization and desire that a new third party needs to rise up and create a thoughtful and convenient way to access and analyze the ETF industry.
An Absent Industry Voice
ETF WikiLeaks would also show an ETF industry that is unable to represent itself in a unified and visible way. Documents would show that this was especially true during recent attacks on the stability of the ETF structure itself as some reporters ended negative ETF segments with the comment that the “ETF industry has not formally responded” to these allegations. Incredibly, there was no unified and visible voice defending the trillion dollar ETF industry against inaccurate charges! Yes, some individual sponsors clumsily hit the media or released a comment. Yes, the ICI ETF Committee met later in the week and then soft launched a statement buried on the ICI website. And yes, these divided efforts were still overwhelmed by the attacks and did damage to the public’s confidence in the ETF structure. The ETF industry needs its own advocacy group to be able to represent global ETF viewpoints, educate the public and remain focused on the unique issues the ETF industry faces. There is too much at stake for investors and sponsors to not represent the ETF industry in a focused and visible manner.