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Behind the Growth in ETFs

Scott Burns

Scott Burns: Talking ETF Trends with State Street.

Hi there! I am Morningstar's director of ETF research Scott Burns.

Joining me today is State Street's head of intermediary distribution, Tony Rochte. Tony thanks for joining me.

Anthony Rochte: Thank you, Scott.

Burns: So Tony what are we seeing in the ETF market right now, trends wise? Who is buying these funds? Who is not buying these funds?

Rochte: As many of your viewers know, and you certainly know, we have seen dramatic growth over the last two, four, and six years. Today there is over a 1,000 ETFs in the U.S. marketplace, over a trillion in assets.

I think what's been fascinating is really the last two to three years. We have seen much more in the way of volume from institutional investors and certainly hedge funds, trading sectors and the industries. So while there are many different types of users, we have seen an uptick in demand from the institutional community, and we think that's had a lot to do with not only increased trading volume, Scott, but also increased assets.

Burns: Well, and I think that's interesting, because I think for a lot of people in the media and even investors, they come to ETFs and say "Wow! These new products, these new ETFs." State Street launched the first ETF in 1994, and I think for a lot of years, it really was just an institutional product. So was there a drop-off in institutional usage and now a ramp-up? What kind of happened in that in between period?

Rochte: If you kind of look at past, present, future. The initial ETF, actually that may have been a trick question. It was actually 1993, Scott.

Burns: Well it was Christmas, right, somewhere around that.

Rochte: Yes, but the point is early on, it was really used just by institutions. If you look from '98 through 2000-2001, that's when the financial advisor began to use ETFs, whether it was the QQQ, whether it was the SPDR, whether it was a new iShare family, you saw more and more demand.

What has been fascinating, though, really in the last few years, particularly post-credit crisis: As investors looked at what they owned, they wanted something that was number-one, collateralized, meaning a '40 Act fund, and in most cases, virtually all ETFs with the exception of a handful are actually '40 Act collateralized obligations. And they really wanted to move away from balance sheet risks. So that's one of the reasons, particularly in the last couple of years, we've seen more and more demand for exchange-traded funds.

Burns: Right, coming from institutions ... you talk about hedge funds, but pension funds, endowments are you seeing more usage there?

Rochte: No question about it. If you look at the 10 largest endowments today in the United States, eight of the 10 actually use exchange traded funds in their portfolios. When you look at institutions, if you go back 8-10 years, they probably used futures and other derivatives, but as they became more and more comfortable with the profile of an ETF, the trading volume, where they can access it via their institutional broker, it became a natural. So we are seeing, frankly, more and more demand from those entities, but foundations and endowments, have used them for a number of years.

Burns: So, even though we are seeing again this renewed uptick in different parts of the institutional investing world, does that mean the advisor adoption is slowing down, or what are you seeing there?

Rochte: No, I don't think that's true at all. I think the first segment of advisors to adopt were the fee-only registered investment advisors. And as the industry has transitioned from a commission-based compensation structure to a fee-based, ETF growth has only followed it. It's very natural. What's interesting, though, is when you look at what a financial advisor can do in a portfolio today versus what they could do five, six, seven years ago. They truly can invest like an institutional investor. They can access international TIPS, they can access currency, global natural resources, commodities, even hedge fund like structures in an ETF. So, I think frankly, the ETF has helped democratize the industry for the financial advisor.

Burns: With that, though, is always the responsibility of understanding these tools. .... Just briefly, what are you guys doing towards educating, with things especially like international TIPS and some of these more esoteric type asset classes?

Rochte: You mentioned it earlier, we pioneered the first ETF 18 years ago. Everything we look at has to have integrity, quality, has to be the right index, has to have the right trading profile. So, that's first and foremost. There are vehicles, Scott, that we've looked at and we've made a conscious decision not to launch, simply because the education that goes along with it is a lot, and may not be appropriate for all investors.

Where I think the industry needs to get better, and what we think about every day at State Street, is really educating the marketplace on, first off, what is an ETF, what can it do for your portfolio, what's good about it, and frankly, where are the speed bumps? Not all ETFs are created equal. You know that, that's what you do for a living, but we take that very seriously.

We think education, whether it's an institutional investor, or frankly, a financial advisor, or now what you're seeing is this burgeoning self-directed market, the education needs to get better, and we're doing a lot in that area.

Burns: Tony, thanks for joining me and talking trends in the industry.

I am Scott Burns.For this and other ETF information, please check out Morningstar's ETF Center on and the Morningstar ETFInvestor newsletter.