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9 PwC ETF 2020Investors in Latin America, theMiddle East and Africa have beenintroduced to ETFs even morerecently. The fact that they currentlyaccount for only 2% of global ETFassets only serves to illustratethe potential for growth in thesemarkets as investors familiarisethemselves with the benefits ofETFs.7There is no consensus on whetherthe North American and EuropeanETF markets are mature. It is quitepossible that growth in thesemarkets will slow, but it is notunreasonable to think that certaindevelopments could reinvigoratedemand and actually cause assetgrowth to accelerate in thesemarkets. Even if Asia becomes thelinchpin for growth in ETF assets,sufficient demand there could easilycause assets to climb past the 5trillion mark by 2020.More segments adoptETFs appeal to a diverse arrayof investors and intermediaries.Everyone from financial plannersto hedge fund managers, insuranceexecutives and central bankers canfind something to like about ETFs.A survey participant pointed outthat ETFs give institutional andretail investors the ability to expressand execute investment views in anefficient, low-cost and transparentway – something that was notpreviously available in the localmarket.2 PwC, ‘Asset Management 2020: A BraveNew World’, 20133 BlackRock, ‘ETP Landscape: IndustryHighlights’, 30 June 20144 ETFGI, ‘ETFGI Monthly Newsletter,July 2014’, 7 August 20145 BlackRock, ‘ETP Landscape: IndustryHighlights’, 30 June 20146 BlackRock, ‘ETP Landscape: IndustryHighlights’, 30 June 20147 See footnote 6 above8 PwC, ‘The Next Generation of ETFs’, 2013As ETFs become more global, theywill find their way into the portfoliosof a wider array of investors. Havingled the way in most markets,advisors to individual investorswill continue to drive demand forETFs. The ease of use, low cost andliquidity of ETFs has made thema favourite among advisors, whoin many cases are taking on moreof a portfolio management role asthe emphasis shifts from securityselection to asset allocation. Thegrowing ranks of affluent investorsin Asia and elsewhere mean demandfrom advisors will almost certainlyexpand.It is institutional investors, however,that are widely expected to be theprimary growth driver in comingyears. Insurance companies, pensionplans and hedge funds in particularare projected to be significantsources of demand for ETFs.Insurers are increasingly lookingto ETFs as sub-account options forincreasingly sophisticated tacticalstrategies.8 Defined benefit planshave already started using ETFsin greater numbers, and definedcontribution plans may well followwith the introduction of moretarget date and target risk ETFs.Having long used ETFs in a varietyof strategic and tactical roles, hedgefunds are unlikely to turn awayfrom an investment vehicle thathas proven so useful in the past.Wealth management platforms,central banks, foundations andendowments are also expected touse ETFs in greater numbers.“ETFs give institutionaland retail investors theability to express andexecute investment views inan efficient, low-cost andtransparent way – somethingthat was not previouslyavailable ”Segment and channel dynamics canvary from one region to another,and differences can sometimes bestriking. The benefits inherent inthe ETF as an investment vehicle arealmost universally seen as the keydrivers of their growth to date. Butdemand has come from differenttypes of investors, depending on themarket. In the U.S., retail demandis more likely to have been seen asa significant growth driver to date.Outside of the U.S., institutional

10 PwC ETF 2020investors are more likely to becredited with having driven assetgrowth in a meaningful way(Figure 1).Figure 1: Significant growth drivers to date (more than one responseprovided)% of linvestorsRetailinvestorsInvestoreducationn U.S. n Non-U.S.Source: PwC Global ETF Survey, September 2014There is noconsensus onthe retirementmarket. Some fundsponsors see it as amajor opportunity,while othersdismiss it as a deadend where ETFscannot competeeffectively.Looking forward, financialadvisors, retail investors and wealthmanagement platforms are expectedto be the top three segmentsdriving demand in the U.S. market.While the retail business is notinconsequential outside of theU.S., demand will most likely comefrom different sources. Insurancecompanies, retirement plans andhedge funds are expected by Asianfirms in the survey to be the biggestsources of demand in the next fewyears. Meanwhile, private banks andwealth management platforms arewidely seen by European firms as asignificant source of future demandfor ETFs (Figure 2).ETF sponsors are considering everyavenue. Sovereign wealth fundsare seen by some as a potentiallymajor source of demand. Others aretargeting local banks and financialinstitutions.There is no consensus on theretirement market. Some fundsponsors see it as a majoropportunity, while others dismissit as a dead end where ETFs cannotcompete effectively.The insurance market is seen bysome as potentially one of thebiggest untapped opportunities forETFs. ETFs have not yet penetratedvery deeply into this massive pool ofassets, but opportunities abound fortheir use, not only as building blocksin packaged products, but also asassets on insurer’s balance sheets.One important area of changein the ongoing evolution ofthe AM business is the role ofintermediaries, who are increasinglyacting in advisory capacitiesrather than simply acting asbrokers. As a part of this shift,these intermediaries are beingcompensated differently, with feeoriented models becoming prevalentin many markets. Asset-based feescreate a powerful incentive to uselower cost investment vehicles inorder to maximise profitability. Thisincentive is made even strongerby the higher turnover associatedwith tactical asset allocation modelsincreasingly used by advisors.The shift towards fee-based modelsis being reinforced by globalregulatory developments, withauthorities in many jurisdictionsaiming to better align the interests ofadvisors with those of their clients.Regulations like the UK RetailDistribution Review (RDR) andMarkets in Financial InstrumentsDirective (MiFID) II in Europe arelikely to lead to interest in cheaperand more cost-effective vehicles.Similar regulations on fee modelsand related disclosures would have acomparable effect on other markets,underscoring the advantages ofETFs and potentially boosting theirshare of retail asset flows.

11 PwC ETF 2020Figure 2: Investor segments projected to generate significant demand (more than one response provided)% of s(retail)WealthplatformsInsurancecompaniesHedge funds/Asset MgrsRetirementplansEndowmentsand foundationsn Significant n Moderate n NegligableSource: PwC Global ETF Survey, September 2014Products proliferateDemand for ETFs is growing asmore investors become familiar withthem. Although new ETFs are notbeing launched at the same pace ofa few years ago, fund managers andsponsors continue to do everythingthey can to meet the needs ofkey investor groups. Rather thandesigning products and hoping theyattract interest, they are meetingwith ETF strategists, investmentadvisors and others to ensure theyunderstand the needs of their coreusers.New types of indexing (also referredto as ‘smart beta’) represent onehotbed of product developmentactivity, with 46% of all surveyparticipants identifying this as themost important area of innovation(Figure 3). Among non-U.S. firms,it ranks first. As they evolve beyondtheir roots, non-traditionallyindexed ETFs are attractingsignificant attention, with a growingnumber of investors opting for indexweightings, based on factors otherFigure 3: Most important area of innovation (more than one g34%Active ETFsNew types of indexingSource: PwC Global ETF Survey, September 2014than market capitalisation, whichcan lead to overly concentratedexposure to certain markets, sectors,or securities. Their vehicle of choiceis an ETF with holdings weighted bycorporate fundamentals (e.g. profitsor dividends), momentum, or someother factor.Central bank

12 PwC ETF 2020There is an ongoing debate overwhether these funds reflect‘active’ or ‘passive’ approaches,but whatever the verdict on thenomenclature, these ETFs aregenerating considerable interest,with growth rates topping thoseof traditional index ETFs and 92billion of assets in the U.S. marketalone by mid-2014.9 Almost half ofthe firms in the survey consider newtypes of indexing to be a key growtharea going forward (Figure 4).Scalability doesn’tappear to be amajor concern.About three infour ETF firms inthe survey claimthat their currentoperationalinfrastructureis sufficientlyscalable. U.S. respondents are particularlykeen on non-traditionalindexing, but they are evenmore enthusiastic about newdevelopments in active ETFs.“It is necessary toconsider the profitmodel and how todeal with lossesbefore productlaunch costs arehigh and ETFs donot necessarilygenerate returns inthe short term.” Alternatives are viewed bysome as an important area forinnovation. A significant number offund sponsors are alreadywaiting in the wings to launchactively managed ETFs. ThisETF executive onproduct strategyFigure 4: Growth opportunities (more than one response provided)Active Non-U.S. firms recognise thelong-term potential of activeETFs, but are quick to point outthe many structural barriersthat need to be dismantledbefore active or alternativeETFs contribute meaningfully togrowth.Service providersevolveWith assets expected to double inthe next five to six years, it is criticalthat the ETF business is supportedby an efficient and scalableoperating infrastructure. Scalabilitydoesn’t appear to be a majorconcern. About three in four ETFfirms in the survey claim that theircurrent operational infrastructure issufficiently scalable. Slightly more than half of the ETFfirms in the survey pronouncedthemselves either satisfied orvery satisfied with quality ofoutsourced services (Figure 5). Some dissatisfaction may stem inpart from a lack of automation,particularly for service providerslocated outside of the U.S., whichis a more mature market.TraditionalindexingAlternativesis particularly true in the U.S.,where the regulatory approval ofnon-transparent active strategiesmay eventually bring a growingnumber of active managers intothe ETF market.New typesof indexingAssetallocation/solutionsn U.S. n Non-U.S.Source: PwC Global ETF Survey, September 20149 Strategic Insight, SimfundMF database, 30 June 2014 High fees are another source ofdissatisfaction, with indexingcompanies most commonly citedas the offending party. SeveralETF firms also say a lack offlexibility on the part of operatingpartners leaves them unsatisfied.

13 PwC ETF 2020 Competition is also puttingpressure on fees. Almost twoout of three service providers inthe survey stated that fees arean issue with which they aregrappling. In many cases, their serviceofferings are integrated andoffered in the form of ‘platforms’.This is business as usual for manyfirms used to the mutual fundindustry, where fund services area mature business.Optimistic economicoutlookETF sponsors are rather morebullish on their financial prospects,with 59% saying they expect theirETF businesses to become moreprofitable this year (Figure 6).Meanwhile, only 14% say profitsare likely to fall in that time. Muchof this optimism has its roots inthe nearly universal belief thatthe market will grow organically,generating additional income. Assetgrowth is likely to be propelled bygrowing demand as well as marketappreciation. Some fee pressure isanticipated, but it is not expected tooverwhelm revenue growth from arapidly growing asset base.Non-traditional index ETFs (socalled smart beta funds) are alreadygenerating significant interest andasset flows, and boosting revenuesfor a growing number of firms.Non-transparent (also known asperiodically disclosed) active ETFsare another example of innovationexpected to directly benefit the topline growth of many asset managers.Figure 5: Level of satisfaction with outsourced operationalservices for ETFs9%12%35%41%Very satisfiedSatisfied3%NeutralUnsatisfiedVery unsatisfiedSource: PwC Global ETF Survey, September 2014Note: ETF managers and sponsors onlyFigure 6: Projected profitability of ETF business in 2014 relative to 201350%% of firms 90% of the service providers saytheir firms have changed theirbusiness model by changingterms or adding resources,streamlining processes,introducing more automation,globalising operations andupgrading technology.26%9%MuchmoreSomewhatmoreAboutthe same12%2%SomewhatlessMuchlessSource: PwC Global ETF Survey, September 2014Improved distribution dynamics arealso seen as a potential source ofstimulus for sponsor revenues. Thisis particularly true in Asian markets,where deregulation and lower crossborder barriers could spur activityand growth.The rise of ETF strategists willcontinue to benefit fund sponsors inthe U.S. market. Already accountingfor more than 100 billion of assets,the 145 strategist firms in theU.S. market continue to introducecomplementary offerings in orderto leverage their distributionnetworks and infrastructure.10 Howquickly the model is applied toother markets remains to be seen,but rapid adoption would benefitmanagers and ETF sponsors.10 Morningstar, ‘ETF Managed Portfolio Landscape’, Q2 2014

14 PwC ETF 2020The impact of traditional marketingand sales’ activities should not bediscounted. Investor educationand brand awareness campaignscould have a meaningful effect onrevenues, particularly in less maturemarkets where ETFs are only nowstarting to find traction among retailinvestors.Growth comes withcosts. Marketingexpenses inparticular areexpected to rise.With competitionheating up invirtually everycorner of themarket, ETFsponsors cannotafford to beoverlooked byinvestors.Meanwhile, deeper penetrationof institutional segments and thebroader secular trend towardsindexing will also continue to benefitthe top line for many ETF sponsors.Growth comes with costs. Marketingexpenses in particular are expectedto rise. With competition heatingup in virtually every corner of themarket, ETF sponsors cannot affordto be overlooked by investors.Gaining and keeping mindshareamong investors and intermediariesmeans increased spending ontraditional marketing campaigns aswell as thought leadership aimed ateducating investors on how best touse ETFs to meet their objectives.Operating costs are also set to rise.Upgrading technology, resources andprocesses will be critical as the ETFlandscape becomes more complicated,with a wider variety of investors and aplethora of new investment strategiesoffered in ETF form.Figure 7: Impact of regulations and tax rules on ETF growth and innovation9%56%35%Significant impactSource: PwC Global ETF Survey, September 2014Moderate impactNegligible impactThe power of policyThe regulatory environmentis widely believed by surveyparticipants worldwide to havemade a meaningful impact on thegrowth and innovation of ETFsto date. Less than one in ten saythe impact has been negligible(Figure 7).Pending regulations are alsoexpected to have a significantimpact on ETFs going forward.New regulations could sparkfurther growth if they permitfurther product innovation or lowerdistribution barriers, but they couldalso dampen demand, particularlyif new tax rules make ETFs lessattractive or convenient.What are some of the key regulatorydevelopments expected to have animpact on the shape and direction ofthe industry’s growth? In early November 2014, theSEC approved a version of nontransparent active investmentproduct called exchange-tradedmanaged funds. There are also anumber of other pending filingsreflecting a variety of proposedapproaches. Will the impact beimmediate? Not likely. But itdoes have the potential to set inmotion a profound rearranging ofprofessionally managed assets. More than three out of four U.S.participants surveyed said theywould expect the regulatoryapproval of non-transparent ETFsto change the ETF landscape inthe future of their firm (Figure 8).In Asia, the three types ofpassporting of funds (see page 18)will necessarily cause regulators towork together to finalise bilateralagreements, be more transparentand clarify rules. The net effectcould be a dismantling of certainregulatory requirements that wereslowing the growth or innovationof ETFs in Asia. The impending‘mutual recognition’ between Hong

15 PwC ETF 2020Kong and mainland China offers anappealing prospect to fund sponsorseager to penetrate the rapidlygrowing market on the mainland,should ETFs be included within itsscope in the future. The successof the Undertakings for CollectiveInvestment in TransferableSecurities (UCITS) framework inEurope illustrates the importance ofthis phenomenon.In Europe, financial transactiontaxes (FTTs) remain an area ofuncertainty. Broad public supportwill likely not be able to overcomefear of adverse economic impact,and failure to agree on commonterms is likely to continue to preventlegislators and policymakersfrom developing the agreementsnecessary for broader enactment.The impact of the proposedEuropean FTT on ETFs will dependon the form in which the FTT isfinally implemented.The distribution landscape is alsobeing reshaped by regulationin Europe and elsewhere. Byeliminating commissions, MiFIDII and the RDR (more in Europe:Regulatory Transformation) areencouraging the use of ETFs. Moreimportantly, they are promotingthe ongoing digitisation of financialadvice. With their specific,liquid, cost-effective exposureto virtually any asset class, ETFsare perfectly suited to new onlineadvice platforms and apps thatare emerging from the shadows oftraditional intermediaries facinggreater regulation.Marketing compliance for ETFs islargely on par with what is requiredfor other investment vehicles, atleast in the U.S. where 58% of ETFfirms in the survey say they arecomparable in cost and complexity.ETF sponsors in other regions do notnecessarily share this perspective(Figure 9).Non-U.S. firms are more likely tosay they expect to see the balanceshift over the next five years, withFigure 8: Effect of the approval of non-transparent active ETFs onyour firm18%23%59%SomewhatNeutralSignificantSource: PwC Global ETF Survey, September 2014Figure 9: Cost and complexity of marketing compliance requirementsfor ETFs vs. other investment vehicles% of firms80%60%40%20

6 PwC ETF 2020 As more types of investment strategies become operationally feasible and are permitted by regulators, a growing number of firms are likely to enter the ETF market. solutions suitable for a rapidly ageing population. Technology could also challenge ETF firms, with its power to radically alter the way investment advice and