How To Profit From The ETF Industry’s Massive Growth (TETF)
Tom Reese
From Grant Wasylik: Asset management is a great business. I should know … I used to work as a portfolio manager, research analyst and trader for a private wealth manager with over $1 billion in assets under management.During my 10 years with the firm, I met hundreds of representatives (analysts, partners, portfolio managers and wholesalers) from various asset management firms (mutual fund families, ETF issuers, etc.).
I also met lots of financial advisers at dozens of industry conferences over the years.
All the asset management professionals I’ve been around have two goals in common:
Help their clients.
Make more money.
Typically, the two goals are tied to each other.
In basic form, asset managers take other people’s money and invest it for them. They make money (fees) off the money they manage. The more money they manage, the more money they make. So, they’re incentivized to grow their client’s assets. In the end, both parties’ interests are aligned.
Because these businesses can increase their size without increasing their costs in the same proportion, they’re very scalable.
In the everyday world, most businesses aren’t scalable. They have to produce more widgets, operate more factories and hire more people to grow. Generally, 10 times the work means 10 times the employees.
Asset managers don’t have these issues. They don’t have to produce more widgets … they don’t have to operate more factories … and for the most part, they don’t have to hire more workers.
On the investment side, this scalability leads to attractive investment potential.If an asset manager receives 10 times more money to invest, the workload barely budges. Basically, they just buy 10 times the investment. For example, 1,000 shares of a stock instead of 100 shares or a $100,000 bond instead of a $10,000 bond. (They can allocate appropriate portions to multiple client accounts.) But, they earn more fees on those additional funds.
There are over 180 publicly traded U.S. companies listed under the “asset management & custody banks” industry.
The biggest names in that group – 20 recognized asset managers like BlackRock, T. Rowe Price and Northern Trust – average 28% net profit margins. (In contrast, the S&P 500 has an average profit margin of 10%-11%.) Those big profit margins from asset managers are due to scale.
At last year’s Morningstar Investment Conference, which I attended, two of the company’s senior analysts outlined key attributes of asset management companies:
Produce a steady stream of fee income.
Generate above average profitability.
Highly scalable.
Require little capital investment.
High switching costs. (For example, the average annual redemption rate for long-term mutual funds is 30%, historically.)
With high profitability, high scalability and little capital investment, the stock prices of publicly traded asset managers tend to move in-line with their assets under management. So, it’s important to know how much money asset management firms have under management. And which way the asset flows are moving or could perceivably move in the future.
One thing we know for certain in “asset flow land” is money is moving from active funds to passive funds. Primarily, the movement is out of mutual funds and into ETFs. ETFs offer several advantages over mutual funds: lower costs, tax efficiency, intraday trading, transparency, better performance and easy access to any area of the markets.
It’s obvious why they’ve been such a slam-dunk choice for investors.
Check out asset flows since the financial crisis …
In the last eight calendar years, mutual funds have lost more than $100 billion and ETFs have gained $1.5 trillion! This movement shows no signs of slowing down, either …
FactSet reported year-to-date ETF inflows tallied $289.4 billion in mid-August this year. Meaning, in only eight-and-a-half months, ETF inflows had surpassed last year’s annual record of $287.5 billion.
Here are a few asset management stocks with noteworthy ETF ties:
There’s also a new ETF – still in its infancy with close to $3 million in assets – that provides broad exposure to the ETF industry. The ETF Industry Exposure & Financial Services ETF (TETF)tracks the Toroso ETF Industry Index (created by ace ETF strategist Mike Venuto).
It holds 43 companies that derive revenue from the ETF business. So, you get ETF asset managers like BlackRock, Invesco, State Street and WisdomTree and more … but you also get index & data companies, trading & custody providers, liquidity providers and exchanges.
As my colleague Mike told me:
We believe these companies have been growing because they represent services and attributes that clients desire; low cost, transparency and tax efficiency, but the future growth will be driven by innovation and access to exposures that have traditionally been available only to institutions.
To gain exposure to the fastest-growing part of the asset management industry, consider adding one of the aforementioned stocks or TETF (learn more about the ETF and index here) to your portfolio.
The growth of ETF assets looks to be an unstoppable force for many years to come.
The ETF Industry Exposure & Financial Services ETF (TETF) was unchanged in premarket trading Wednesday. Year-to-date, TETF has gained 16.59%, versus a 14.96% rise in the benchmark S&P 500 index during the same period.
