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ETF Goliaths Better Watch Out for the Davids

While the big guns have been battling it out in the war for assets by lowering fees, some lesser-known players are stealing market share from under their noses.

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Every month, the universe of exchange-traded products is expanding and taking market share from the mutual fund industry. In January 2011, assets in U.S. ETPs (exchange trade products) reached a new record of about $1.02 trillion, up from $744.7 billion a year ago, according to the National Stock Exchange. A few large players, including BlackRock, State Street Global Advisors, and Vanguard, dominate the share of the market. But with all this money swirling around in the ETF marketplace, the smaller firms want a piece of the pie.

While the big guns have been battling it out for the largest chunk of the asset space by lowering their prices, some of the lesser-known players are creeping up behind them, stealing some of the market share from under their noses. How are they doing it?

Larger players in the ETF industry space primarily focus on the core asset classes—stock and bonds—but other players are specializing in “explorer-type strategies,” says Christian Magoon, CEO of Magoon Capital, an asset management consulting firm. This includes commodities, alternative weighting schemes, currencies, and other investments that have a twist on traditional strategies.

According to Magoon, PowerShares was the first startup firm to do this with its Intellidex-based funds, which explored different weighting schemes. Now, PowerShares is owned by a multi-national company, Invesco, and it’s the fourth-largest ETF provider in the country. “PowerShares kind of blazed the trail.”

WisdomTree, now the eighth largest ETF player, set out to capture a piece of the cap-weighted assets when it rolled out a platform of dividend-weighted funds in 2006. Bruce Lavine, president and chief operating officer, said the entire world indexing has grown up around cap-weighted strategies, but the company wanted to offer something different. “We think that the world just doesn’t need another cap-weighted fund,” he said.

Now the company has about $10.2 billion in assets. Last month, WisdomTree launched the first managed futures strategy in the ETF space.

Michael Johnston, senior analyst at, said it makes sense to go after these smaller, specialized markets as people have more confidence that ETF assets will continue to grow. For example, if equal-weighted strategies represent 1 percent of the market, that piece of pie will grow if the entire industry grows to several trillion.

Another firm to differentiate itself in this way is Rydex SGI, which launched its flagship S&P Equal Weight ETF (RSP) in 2003. The fund now has over $3.4 billion in assets. From 2006 to early last year, the company hadn’t rolled out many strategies, but with the change of ownership to Guggenheim last year, Rydex had more money to invest, said Tony Davidow, managing director and portfolio strategist. In December and January, the firm expanded its equal-weight platform, with the addition of six funds: the Rydex Russell 1000 Equal Weight ETF (EWRI); Rydex Russell 2000 Equal Weight ETF (EWRS); Rydex Russell Midcap Equal Weight ETF (EWRM); Rydex MSCI EAFE Equal Weight ETF (EWEF); Rydex MSCI Emerging Markets Equal Weight ETF (EWEM); and the Rydex MSCI ACWI Equal Weight ETF (EWAC).

“We want to known as the home of equal-weight strategies,” Davidow said. The executive wants the Rydex name to be tied to the equal-weight brand, and hopefully, investors will come knocking on their door. As of the end of 2010, Rydex holds 0.6 percent of the ETF market share, according to BlackRock data, but Davidow expects to be a much bigger player as the industry gains assets.

Rydex has registered to offer 13 more products, and they’re entertaining the idea of launching equal-weighted countries funds and equal-weighted fixed income products, he added.

“We’re democratizing what had primarily been an institutional product,” he said.

Newer Entrants

The ETF business is looking more and more like the mutual fund industry, as mutual fund companies, such as BlackRock, Invesco and Guggenheim, are snatching up ETF providers. This has provided more opportunity for new entrants into the market, said Magoon. These newer entrants are not encumbered by the legacy asset management bureaucracy, allowing them to be more innovative.

One such newer entrant is IndexIQ, which launched its first hedge fund replicator strategy in March 2009. CEO Adam Patti said the firm wanted to take index-based methodologies and apply them to institutional, complex strategies. IndexIQ is trying to own the alternative space.

Last year, the company added four new single-country small-capitalization ETFs to its alternatives platform. In the last year, IndexIQ’s ETF assets have grown from $120 million to $359 million as of the end of January 2011, according to the company.

While many of these funds have generated interest and assets, not every fund family will be successful in these strategies.

“Unique is not enough to guarantee success,” said Johnston.

One company that did not succeed in offering niche products was FocusShares, which introduced four ETFs in 2007, including its Homeland Security Index Fund (MYP). In October 2008, all four funds were liquidated. But after the firm was acquired by Scottrade in 2010, it abandoned the niche market and registered with the Securities and Exchange Commission to roll out a suite of broad-based asset ETFs, which are still in the works.

Wising Up

But now some of the larger ETF providers are wising up and realizing the benefits of offering more specialized products. With broad-based asset classes, some firms have realized that it’s a commoditized area, and the only way to control inflows and outflows is through expense ratio. “How far will those core assets go in terms of expense ratios?” Magoon asked.

With the success of these smaller companies moving into these non-traditional strategies, State Street and BlackRock have started building out their specialized products as a way to stem the losses from fee reductions on the core asset side, Magoon said. At the end of 2009, iShares came out with its Diversified Alternatives Trust (ALT) ETF. iShares also offers a BRIC fund, subset China funds and a timber product. State Street introduced industry-specific products. Vanguard is the exception, however, and has continued full speed ahead with its core asset offerings.

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