ETFs End Rough 2011 Stronger

The Financial Times came out with a special report on ETFS today. It said the industry’s breakneck growth rate slowed as it faced adversity last year in the form of weak stock markets, and media hostile for the first time and “unprecedented criticisms from regulators.” And while net inflows of cash fell year-over-year, it still market a striking contrast to the “substantial net outflows” mutual funds saw on both sides of the Atlantic.

Even as investors sold moved out of stocks, especially in Europe, exchange traded products (ETPs) moved into the role of a risk reducer as they were used as a way to buy gold. Gold ETFs in Europe saw inflows of 730 million euros. So are this year, the SPDR Gold Shares (GLD) in the U.S. has seen inflows of $1.32 billion, compared with net outflows of $518 billion for all of last year.

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FT Says ETFs Are Reaching Saturation Point

The U.S. ETF market may be getting saturated, says the Financial Times, as the appetite for new funds wanes. Last year, a record 302 exchange traded products were launched, a little less than the 389 funds that made up the entire market in 2007. At the end of 2011, there were 1,369 ETPs with more than $1 trillion in assets under management.

However, of the 190 ETFs launched in the first six months of 2011, 79% failed to reach the profitability mark of $30 million in assets under management, according to XTF, an ETF-focused research house. This was up from 62% in 2010 and less than half in 2009.  Fewer assets in the funds means less liquidity and wider bid-ask spreads.

Mel Herman, the head of XTF, says, said: “Most popular indices already have an ETF tracking them, so issuers are launching more and more niche products.”

I’ve been saying this for two year. A big difference between mutual funds and ETFs is that you don’t see many ETFs tracking the same index while each mutual fund sponsor can have their own set of index funds that track the S&P 500, the MSCI or any other popular index. The reason is twofold. Many mutual fund companies run 401(k) plans. So, they need to offer a wide range of options in the plan. Since plan participants are usually trapped and unable to buy funds outside the plan sponsor, these copy-cat index funds can build up significant assets. Also, many mutual funds are sold by investment advisors who receive a commission, or load, from the fund company. Thus, competing funds tracking the same index can build up assets as advisors direct investors which fund to go into.

Typically, the first ETF to track an index claims that market segment for itself. By the time a second fund launches, the first ETF has made a reputation and gathered a large amount of assets, making it much more liquid than any newcomer. For instance the SPDR S&P 500 (SPY), which launched in 1993, has net assets of $95.4 billion, while the iShares S&P 500 Index Fund, which launched seven years later, has only $26.2 billion.

This syndrome where the first ETF grabs all the assets and attention is called “first-mover advantage.” Since ETFs don’t have the captured audience of 401(k) plans or loads to pay to advisors, no one is there to push smaller funds, hence there are few funds tracking the same index or asset.  This means ETF sponsors need to find new indexes to track. But after a while, the indexes get so specialized they only attract a small audience. In addition, in volatile times, investors are less willing to risk investing in an offbeat concept. They want proven indexes that track broad markets. So, until investors are willing to take on more risk, unless an ETF concept is compelling, new funds will continue to struggle for assets.

BGi’s Diamond Scores $36.5 Million; Vanguard Investors Pissed Off

Here’s a round-up of second day stories about the Blackrock purchase of BGI.

The Wall Street Journal says more than 400 top executives at Barclays will walk away from the deal pocketing a total of $630.3 million. It seems there was some sort of unusual management incentive plan in place at BGI that would have started to expire in 2010. They needed to do something quick to cash out. Barclays President Robert Diamond alone will walk away with $36.5 million.

WSJ’s Jason Zweig reports that Vanguard’s investors are furious with the mutual fund/ETF company for even making a bid on iShares. Zweig says this could have been a good move for Vanguard and I agree. Already the No. 3 ETF provider, Vanguard could have become the market leader. More important, Vanguard would have probably cut the expense ratios on the ETFs, which could have brought in even more investors. Few people realize that Vanguard doesn’t have an ETF to partner with its S&P 500 fund. Vanguard came to ETFs late in the game and wanted to make an ETF for its flagship index fund. However, S&P had already given an exclusive license to BGI for the iShares S&P 500 Index (IVV).This would have given Vanguard the S&P 500 ETF they’ve always wanted. Also, S&P sued Vanguard over basing the ETF on the index without giving S&P any additional licensing money That full story is in ETFs for the Long Run.

The Financial Times says Larry Fink, Blackrock’s CEO, has been trying to buy BGI for eight years, and capitalized on the financial crisis to make his dream come true.

Reuters’ Svea Herbst-Bayliss suggests the BGI deal will spark a buying spree as envious rivals figure out how to compete. Bank of New York Mellon (does that taste as good as a honeydew melon?) is expected to be the next buyer. BNY already plays a big part in the ETF industry as a trustee and custodian of many funds. BNY is the trustee and administrator of the second ETF, the MidCap SPDR (MDY).

DealJournal’s Michael Corkery says besides CVC, the big loser is Goldman Sachs, which advised CVC.

Jim Wiandt of IndexUniverse.com says by using an ETF company to create the largest asset manager in the world is a huge boost for the ETF industry and proves how big basis-point-linked passive assets have gotten. He asks a lot of questions, but doesn’t give any anawers. Questions like will Blackrock keep the ETF expense ratios low and what does this mean for the active ETFs?

What are your thoughts? I would love to hear them.

BlackRock Rumored to Buy BGI; BNY Could Enter the Fray

Kudos to Douglas Appell and Pension & Investments for breaking what may be the biggest scoop of the ETF industry this year.

Pension & Investments reported just before the market closed Friday that giant money manager BlackRock made a late day play for Barclays Global Investors. Unnamed sources say, “BlackRock is likely to announce an agreement to buy BGI, creating the world’s biggest institutional money manager.” The source expects the announcement within days. BGI owns the iShares exchange traded fund business.

Big British bank Barclays put the unit up for sale earlier this year in an effort to raise capital and stave off the British government either investing in or nationalizing the bank. CVC, a British private equity firm, offered in April to buy iShares for $4.2 billion. BlackRock is expected to trump that with a $10 billion offer. CVC holds the option to make a counter bid. But a source not directly involved in the deal said CVC wouldn’t be able to top the BlackRock offer.

I love how every story crediting Appell calls him a veteran journalist. What makes one a veteran journalist vs. a regular journalist? I’ve heard of rookie journalists. But after the first year, aren’t all journalists “veteran journalists”?

This morning, the New York Times confirmed the story. Negotiations appear stuck on the issue of price. Barclays wants “more than $12 billion.” Vanguard Group, the providers of a large family of ETFs and mutual funds, had previously been mentioned as a buyer.

This story cleared up one question in many people’s minds: Is this for iShares alone or all of BGI. The Time says all of BGI, which operates in 15 countries with more than $1 trillion in assets under management. If the deal goes through, Barclays could end up with a seat on BlackRock’s board.

The Financial Times confirms the story and raises the ante. FT.com reports Bank of New York Mellon is about to stage an 11th -hour challenge for BGI. FT predicts the deal could come in around $13 billion, with Barclays taking a 20% stake in Blackrock.

I want to know where is Fidelity, the mutual fund giant? Fidelity missed the boat the first time and here’s its chance to be one of the largest in the mutual fund and ETF businesses in one fell swoop.