Ready, Fire, Aim: The ETF Industry Blasts Its Spaghetti Cannon

A version of this article was published in the May 2016 issue of Morningstar ETFInvestor. Download a complimentary copy of ETFInvestor here.

As of June 15, there were 1,926 exchange-traded products, or ETPs (the term includes both exchange-traded funds and exchange-traded notes), listed on U.S. exchanges. This number has increased without interruption since the first U.S.-listed ETF,

Two-plus decades later, there is an ETF offering exposure to virtually every fine slice of every asset class, every strategy, and every theme under the sun. ETF providers have designed a whole tackle box full of shiny new lures (hat tip to Research Affiliates' John West for the analogy), but most investors haven't taken the bait.

Of the 1,926 ETPs in existence today, the top 100 of them as measured by assets under management account for 74% of total ETP assets. These funds share the hallmark characteristics of the ETF "brand": They are generally low-cost, liquid, and tax-efficient vehicles offering broad asset-class exposure. The average fee among these top 100 is 0.22% (0.19% on an asset-weighted basis). The average fee for the remaining 1,826 is 0.55% (0.44% on an asset-weighted basis). The median number of shares of each of the top 100 ETPs that have traded hands on a daily basis during the past three months was 1.6 million. The comparable figure for the remainder of the universe was just over 21,000.

The asset-management industry has blasted its spaghetti cannon, with investors playing the role of the wall. Fortunately, many investors have displayed a nonstick coating, ignoring the allure of faddish new launches such as Sprott Buzz Social Media Insights ETF BUZ and Global X Millennials Thematic ETF MILN. But that won't keep the industry from firing volley after volley, trying to get something to stick.

The ETF industry has leveled the playing field for investors, chiefly by bringing down investment costs and expanding investor access. These same factors have simultaneously lowered barriers to entry for asset managers, allowing new players to enter the space at a far lower cost relative to launching an actively managed mutual fund, for example. Given the relatively low hurdles facing prospective entrants and the large potential rewards, it's no surprise that there has been a gold rush in the ETF space.

While there are new funds coming to the market that are worth your attention, most are mere novelties. When it comes to choosing from the menu, most investors would do well by keeping things simple and keeping costs low (the two tend to go hand in hand). Though there are now more than 1,900 products to choose from, most of us could build a perfectly suitable, low-cost portfolio selecting a small handful of the 100 largest ETPs.

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