Eyeing ETFs' Next Chapter

This article first appeared in the August/September 2011 issue of Morningstar Advisor magazine. Get your free subscription here.

When did the light turn on for you that ETFs would be a big business?
We saw flickers here and there earlier, but by 2000, we knew these products truly could offer all of the important benefits that advisors wanted in a mutual fund, such as transparency, tax efficiency, and lower fees.

Fact or fiction: One day, ETF assets will surpass mutual funds?
I wouldn't bet on it anytime soon, since ETF assets are sitting at about 10% of the assets in mutual funds. ETFs and mutual funds are complementary products and can work well together.

Are you surprised by the growth of index investing over the past decade?
Not at all, but I believe you can build a very active portfolio using passive investments. We saw institutional investors move about $1 trillion to passive investments in the 1990s, and they've mostly been pleased with those decisions. We're not surprised that forward-thinking advisors think the same way.

What's the trend you like most in the ETF market?
We're excited to see the trend toward identifying a next generation in terms of product lineup. Increasingly sophisticated investors have newfound expectations for more solution-oriented options.

What's the biggest misconception about ETFs?
The misconception that trading volume equals liquidity. Many advisors just look at the daily volume of an ETF in order to gauge if the ETF is liquid. However, as long as the ETF is designed properly and the underlying securities in the ETF are liquid, that particular ETF should find a good market to trade.

Actively managed ETFs: distribution-model disruptor or dead on arrival?
Neither. Investors need to see performance and the ability of a portfolio manager to deliver investment returns, and that will take time. Even so, it all boils down to risk and return.

What's the gravest threat to ETF industry's success?
Similar to mutual funds, ETFs are here to stay. Sure, other products may come along that look new or creative, and of course, ETFs need to deliver on the investment promise that advisors are expecting, but I don't foresee any grave threats.