How the ETF industry is evolving at epic speed

As the ETF industry continues to evolve, so is the world's largest conference dedicated to them. Find out more from one of our speakers below, Nate Geraci, President, The ETF Store.

Change is constant. Adapt to thrive. Evolve or die. The ability of financial service providers to adjust in a constantly changing competitive environment is crucial to survival and success. Advisors, fund issuers, index companies, and other service providers must continually adapt to unpredictable financial markets, changing client preferences, evolving regulations, and new technologies.

So what's changing exactly?

Consider the monumental changes in ETFs over the past few months:

• ETFs now trade commission-free at every major brokerage. Another cost of investing has suddenly vanished. Pay-to-play commission-free ETF platforms are dead.
• The SEC passed the ETF Rule, meaning ETFs are no longer required to operate through loopholes and exemptions. ETF are all grown-up now, with their own regulatory framework nearly 27 years after the launch of the first US-listed ETF.
• The SEC also gave the nod to several non-transparent ETF structures, which allow fund managers to conceal their investment picks and still leverage the benefits of the ETF wrapper.

Each of these is potentially disruptive. Commission-free trading further disadvantages mutual funds, a decent chunk of which still incur transaction fees at brokerages. Mutual fund companies used to ridicule ETFs over their ticket charges.

Now the tables have turned. Commission-free trading also allows smaller ETF issuers to get a fairer shake since big-budget fund companies can no longer purchase an audience of investors seeking no transaction fee ETFs.

And, what happens to upstart brokerage firms like Robinhood who initially built business models on commission-free trading?

Playing by the rules

The ETF Rule makes it easier for fund companies to bring new products to market, which should lead to more launches, innovation, and competition.

The playing field has been leveled with nearly all ETF issuers functioning under the same set of rules. The ETF Rule will also help ETFs operate even more tax efficiently and with tighter bid-ask spreads, given the ability for all issuers to now use custom baskets. The ETF wrapper becomes even more compelling for investors.

Non-transparent ETFs offer an option for skittish mutual fund companies to leverage a superior investment delivery vehicle, while still protecting their “secret sauce”. Active managers have struggled to generate consistent outperformance.

Consider financial advice. Gone are the days when advisors could offer cookie-cutter asset allocation for a 1% asset management fee.

Non-transparent ETFs could allow active managers to offer strategies at a lower cost and with less tax drag. Could that help close the performance gap?

Regardless, non-transparent ETFs are something traditional mutual fund companies will have to contend with either through direct competition or the potential cannibalization of their own mutual funds.

How will this impact financial advice?

Commission-free trading, the ETF Rule, and non-transparent ETFs may each require fund companies to evolve in varying ways as they face new competitive threats. The need to adapt isn’t limited to fund companies, however.

Consider financial advice. Gone are the days when advisors could offer cookie-cutter asset allocation for a 1% asset management fee.

Technology has introduced robo-advisors that are more than capable of doing this, along with offering features such as tax loss harvesting and automated rebalancing - all for a fraction of the traditional cost of advice. Larger asset managers are rolling out advisory services staffed with CFPs and charging Neflix-like subscription fees.

For everyone in the financial services industry, education is paramount.

Investor expectations are evolving. Consumers are used to interacting with companies like Netflix, Uber, or Amazon. On demand. Easy-to-use technological interfaces. High value-add. Financial advisors must adapt to this new reality.

Along with this, advisor fee models are being called into question. Will the fee compression witnessed in the fund industry find its way over to financial advice? % AUM, flat fees, subscription-based, hourly, commissions, % income – which is the right fee model? How should these fee models be priced?

A change is 'gonna come

As a new decade gets underway, change is in the air for the financial services industry. That said, the more things change, the more they stay the same. Regardless of new business models, regulations or technology, a solid value proposition will always have an audience.

Communicating that value proposition becomes ever more important. With ETFs now commission-free, products can stand on their own merits. However, those merits must be clearly communicated to investors.

ETF issuers can offer differentiated strategies, superior client service and/or compete on cost – but remaining stagnant is not an option. For advisors, the exact same holds true. Have a niche, deliver exceptional client service, and/or compete on cost. The status quo is no longer enough.

For everyone in the financial services industry, education is paramount. Without understanding which way the winds of change are blowing, how can you adapt? How can you evolve? This year’s Inside ETFs will focus on the key changes and evolution across our industry. It’s an event few of us can afford to miss.

Nate is President of The ETF Store. He will be moderating the panel discussion “How You Should Really Get Paid” at Inside ETFs on Tuesday, January 28^th at 1:50pm.