(Repeats Feb. 16 story for wider readership)
By Daniel Bases
NEW YORK Feb 16 Increased use of asset allocation models and fee-for-service investment advice will help push the amount of cash into exchange traded funds (ETFs) over the $1 trillion mark in two years, a new study predicts.
These two major shifts in how money is invested helped pump the ETF market to more than $725 billion globally by the end of last year, New York-based mutual fund research firm Strategic Insight (SI) said.
"ETFs are benefiting from the trend of the investment community moving into a compensation model that favors fees for advice instead of point-of-sale commissions," Loren Fox, senior research analyst at SI, told Reuters in a recent interview.
Fox, a lead writer of the study set for release on Tuesday, said the overarching theme is a broadening and deepening of the ETF investor base. First appearing in 1993, ETFs are touted for their ease of use, tax efficiency and low cost to manage.
They also offer investors a way to target specific asset classes efficiently and increasingly are used as a hedging tool for portfolios, large or small.
As a result, retail rather than institutional investors hold a slight majority of ETF assets, SI found.
Even during the market meltdown of 2008, investors worldwide poured more than $260 billion into ETFs.
In the largest market, the United States, ETFs took in a net $176 billion in 2008, up 29 percent over 2007. However, market declines took the total value of U.S. ETF assets down to $536 billion at the end of last year from $614 billion at the end of 2007, Fox said.
Net inflows into European ETFs rose an even faster 57 percent or $74 billion last year. The total value of European ETFs rose to $145 billion in 2008 from $130 billion in 2007.
Growth in Asia, while showing potential, suffers from a slower uptake of passive investment vehicles, SI said.
Worldwide mutual fund assets fell in the third quarter of 2008 to $21.66 trillion from $24.65 trillion in the prior quarter, industry trade group Investment Company Institute said, citing the latest available data.
The U.S. mutual fund industry saw assets drop to $9.6 trillion last year from $11.99 trillion in 2007, ICI said.
ASSET ALLOCATION MODEL
SI's research highlights investor behavior evolving over time from stock brokers making the case for a specific stock, to the buying of mutual funds, to what it calls the the latest "tectonic" shift of selling investors entire portfolios.
"Throughout the mutual fund industry, nearly $1 trillion in aggregate has been net invested over the past five years in asset-allocation vehicles, including target-date retirement funds, balanced funds, and mutual fund wrap programs," a portion of the study obtained by Reuters said.
"This shift in emphasis to asset allocation helps ETFs, as most ETFs enable straight asset allocation," SI said.
Fox said SI surveyed 85 registered investment advisers on their use of ETFs and found 24 percent plan to boost the use of ETFs "much more"; 49 percent would use ETFs "a little more"; 22 percent would use ETFs "the same amount"; and 5 percent said they would use them a "little or a lot less."
"The financial crisis has put many broker-dealers in flux, likely accelerating further shifts away from national broker-dealers and towards financial planners, independent broker-dealers and RIAs," the study said.
In addition to evolving investment habits, new products such as last year's introduction of the first U.S. actively managed ETF is expected to fuel sector growth by appealing to investors looking for professional management with the ability to utilize the ETF structure.
SI says by the end of 2008 there were 13 U.S. actively managed ETFs with about $240 million in assets.
However, market conditions, lack of investor education and an appeal more to retail rather than institutional investors may limit their near-term growth.
"With active ETFs they won't have an index to point to. On top of that it is anyone's guess how challenging 2009 will be generally," said Fox.
The dismal credit market conditions are also putting a damper on the $4 billion worth of exchange traded notes, ETF-like debt instruments issued by banks, SI says.
"ETNs are a compelling product but in the near-term face challenges because investors take on credit risk ... with the credit risk of banks all over the world a real source of anxiety, what had been a fast growing segment has slowed," said Fox. (Editing by Matthew Lewis)