Rapidly Growing ETF Industry May Need Its Own Trade Group

As the exchange-traded fund industry continues to grow in size and popularity, it's beginning to look as though the more money investors pour into its coffers, the more problems the industry may potentially have to address.In August, the Securities and Exchange Commission issued an alert about leveraged and inverse ETFs, warning of the risks they pose to buy-and-hold investors. And throughout 2009, observers warned of bubble-like qualities in ETFs, which number more than 800 and continue to grow. So with ETFs on track to surpass $1 trillion in assets in 2010, should an independent trade organization be established to maximize their marketing, as well as address the education of consumers and market players about their possible risks?

%%DynaPub-Enhancement class="enhancement contentType-HTML Content fragmentId-1 payloadId-61603 alignment-right size-small"%% Well, an organization already exists that is supposed to do that – it's the Investment Company Institute, a trade group that protects the interests of mutual fund operators and other investment companies. The ICI has done a great job up until now, but some in the industry feel that as ETFs continue to grow, they will inevitably begin to compete with mutual funds for investor assets, placing the ICI in the difficult position of being unable to market, advocate for and educate the public about each product fairly without offending the other.

Conflicts of Interest Within the ICI

"Five years ago, ETFs were not a threat to the [mutual] fund industry," says Tom Lydon, founder of ETF Trends. "Today, it's more of a reality that ETFs may be digging into the market share of the more conventional mutual funds. If you are a middle of the road mutual fund company and you have so-so performance, and average or above-average fees, as time goes on, ETFs will be a bigger and bigger threat to you."

Moreover, a threat to the mutual fund industry could be interpreted as a threat to ICI, since its primary members are the mutual fund companies which pay its fees. In an email responding to questions, the ICI defended its work with the ETF industry:
"ICI's Board of Governors formed a Standing Committee on Exchange-Traded Funds in 2008 that works on behalf of this important and growing segment of ICI's membership. ICI serves the ETF segment of the fund industry in important ways, including presenting a unified voice to regulators and applying ICI's research and communication resources to improve industry and public understanding of ETFs."

While Lydon said the ICI committee was "the right first step," he also admitted that "there hasn't been a lot of substance that has come out of these meetings." In fact, when DailyFinance asked the ICI to address specific concerns about speculation in the ETF industry, we were referred back to the above email response. Not quite the answer investors would want.

ETF Growth Requires a Proactive Stance

"The ICI may do some things to a point, but they are not out there looking to defend ETFs necessarily," says Irving Straus, a mutual fund and securities industry veteran who is pushing the issue of starting an independent organization for ETFs as executive director of the ETF Council Inc. He plans to officially announce the organization this month.

Straus believes that the easy money in the ETF industry has already been made, and growth will only continue with a strong marketing and education campaign -- not by continually coming up with new ETF products. He also says that regulatory scrutiny of ETFs and ETNs is likely to increase as assets under management grow, which is why he believes a proactive industry response is needed.

Whether ETF providers agree with him is uncertain -- his biggest challenge is convincing ETF providers to join his new trade group. Since many of the mutual fund companies also produce ETFs, they may not see the value of paying dues to two separate trade groups at this early stage in the ETF industry's development. Lydon estimates that ETFs only make up about 7% of overall mutual fund assets, such a small portion of the industry that an independent organization probably isn't needed right now.

However, bigger players such as T. Rowe Price (TROW), Charles Schwab (SCHW), and Goldman Sachs (GS) have started to expand into the industry, and they may pressure ICI to be more vocal in promoting ETFs, which potentially have greater growth potential than mutual funds. If the ICI doesn't respond, perhaps an independent group will emerge. If the Closed End Fund Association, which educates investors about the benefits of closed-end funds over other mutual funds, can operate independently of the ICI, perhaps the ETF Council may have a shot.
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