The range of new ETFs coming to market is changing the complexity of the industry by tracking less well-known benchmarks, according to Morgan Stanley Smith Barney Research.
The firm's latest report on the US-listed ETF market for the third quarter says funds replicating new or non-mainstream benchmarks have heightened the importance of industry analysis, to help differentiate among products.
The report says: "We believe investors should carefully consider the investment objectives, design and structure of ETFs as their performance might deviate meaningfully from established benchmarks."
For example, the report identifies some of the newer fundamental or rules-based indices may have a tilt towards small or large cap growth or value stocks, that have shown historical outperformance, when these market segments outperformed.
Conversely, this can lead to underperformance when these market segments lag.
Yet the report says the evolution of the US ETF industry is as impressive as its continued growth. The market has significantly developed since the first vanilla funds based on broad market cap-weighted indices first emerged in 1993.
Newer ETFs have evolved to include those tracking indices with different approaches to weightings, indices using rules-based models for stock selection, and thematic indices.
Some of the ETFs to have emerged in the last few years also provide exposure to leveraged and inverse returns, foreign currencies and commodities.
Nonetheless, many of the newer funds tend to have higher relative fees and turnover, as well as potential tax implications.
Many of the newer listings have also struggled to gain traction, competing with well-established funds that have more assets under management. The report says 403 ETFs launched since the beginning of 2008 have an average market cap of $133m, but a median market cap of $23m.
Although some of these products offer unique exposure, flows have been limited amid a turbulent economic environment. This relates to those ETFs with a narrow focus based on less well-known indices in particular.
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