Why global ETF assets are set to double over the next five years

We explain why index funds and ETFs will continue to prove popular with investors. 

Investor demand for exchange-traded funds (ETFs) shows no sign of slowing down, with accountancy firm PwC forecasting that global ETF assets will double in the next five years to $20 trillion (£14.7 trillion).

Invented in the early 1990s, ETFs are investment funds that can be traded on stock exchanges in the same way that equities are. ETFs began life as a way to track a broad basket of stocks using an index, such as the FTSE 100 or S&P 500. 

Investors still mostly use ETFs to track these well-known indices. However, over the years, ETFs have become more sophisticated. They now offer the ability to track a basket of a wide range of other asset classes such as bonds, property, currencies or commodities (including gold and oil). They can also be used to track more niche baskets of stocks, including themes, such as cloud computing and robotics.

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PwC notes that the next phase of growth and innovation for ETFs will include active strategies, cryptocurrencies, and environmental, social and governance (ESG) focused products.

In particular, PwC highlighted ESG as a growth area that ETF providers could capture. 

It said: “If the arrival of ETFs marked the biggest single development in money management in the last 30 years, ESG is set to be the next. With Europe leading the way, many investors are now beginning to scrutinise ESG performance as closely as financial returns.

“The focus on ESG opens up opportunities to drive more product innovation. This includes creating more bespoke indices that are focused on environmental objectives to meet the growing demands for sustainable investments from investors.”

PwC notes that there have been questions over whether ETF demand will hold up in the event of a serious setback for stock markets. However, it points out that during the pandemic “ETFs as a whole demonstrated their resilience across various segments and geographical markets”.

A separate report from data provider Morningstar found that in 2021, ETFs accounted for 49% of global net flows. Given that ETFs represent 21% of global assets, Morningstar says this suggests that ETFs will soon capture the majority of net global flows in 2022.

Why are index funds and ETFs selling like hot cakes?

In 2007, before the financial crisis hit, the amount held in trackers was a mere £29 billion, which at the time represented 6.3% of the total invested in funds.

Fifteen years on, the latest figures from the Investment Association (IA) show that tracker funds’ assets now stand at £298 billion. Their overall share of industry funds under management is 18.8%. 

Over the years, various academic studies have questioned active funds' ability to consistently add value.

Even Warren Buffett, one of the world's greatest investors, is sceptical about the merits of active funds. Buffett has instructed the executors of his will to buy an index tracker for his widow, and he has selected his preferred choice: Vanguard's S&P 500 index fund.

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Lower costs, with some tracker funds charging less than 0.1% versus typically around 0.9% for an active fund, is a key attraction.

Simplicity is another. Investors - particularly those who are younger - favour the certainty offered by a fund that will do what it says on the tin. With active funds, in contrast, investors are buying in the hope that the fund manager outperforms the index.

Another key advantage of ETFs is that they offer private investors access to previously hard-to-reach areas of the market. Prior to the invention of ETFs, investors would have struggled to find a way to gain direct exposure to the price of oil, or easily track a basket of value stocks.

The main disadvantage is that an ETF, by design, will not usually outperform the index it is tracking. Actively managed funds, run by fund managers, aim to provide outperformance, but there are no guarantees it will be achieved.