ETF Perspectives: Industry Outlook

In a new Citi Research note, a team led by Head of ETF Strategy & Analysis Scott Chronert takes a look at the exchange-traded funds (ETF) industry and its prospects. As we note in this annual outlook, the ETF industry has thrived since the Global Financial Crisis, with U.S.-listed assets under management (AUM) now topping $10 trillion. We see a path to another $10 trillion by the end of the decade, but it will be an evolving roadmap.

Five years ago, we projected that the U.S.-listed ETF complex would now have $8.5 trillion in AUM; in fact, the complex recently hit $10.4 trillion in AUM. That exceeded our base case by some $2 trillion, though it fell short of our bull case. There have been many factors influencing this growth, with the ETF industry continuing to demonstrate an uncanny ability to adapt to changing market conditions, offering innovative new products and use cases.

We expect aggregate ETF AUM to continue expanding, as recent use-case success keeps feeding on itself. But we also expect some product consolidation to offset an ever-changing opportunity as markets evolve.

Our updated projections suggest that the next $10 trillion in AUM could come near the end of this decade, with industry AUM nearly tripling by 2035. The keys will be continued market gains, albeit at a slower pace; ongoing shifts from mutual funds to ETFs; and the expansion of asset classes/strategies available in tradable wrappers.

ETF investing: Unpacking the product landscape and profitability puzzle

Not long ago, we were talking about surpassing 3,000 ETFs listed in the U.S. Now there are more than 4,000, and the annual revenue run rate of those products (think AUM multiplied by expense ratio) is approximately $18.1 billion. But we believe at least a third of products aren’t covering their operating costs, while 10% of issuers with at least eight products on platform are unprofitable.

Last year, ETF debuts in the U.S. outpaced closures by four to one, the second-highest ratio in the last 10 years. 2024’s launches were heavily equity-focused, but we also note that fixed-income launches have been accelerating, especially as liquidity backdrops improve in more sub asset classes.

Closures significantly slowed in 2024 after a record rate in 2023, which we find of interest. But we suspect closures may accelerate again as ETF issuers outside of the top tier refocus on profitability by rationalizing ETF offerings within the same category, or which provide similar characteristics. 

We estimate around 500 products may be at relatively high risk of closing or changing strategies in the medium term if they’re unable to cover estimated operating costs after five years of trading. Given platform considerations it’s unlikely all will close, but we could see an annual closure run rate near 300 this year and next, above historical averages.

Next, we update our ETF trading use-case checklist, which helps us track the user base for ETFs. The more data points an ETF checks off, the more likely it is to be used by larger institutions in a more tactical and two-way fashion:

In considering evolving portfolio construction, we have been fully on board with a shift away from traditional categories to a more core/satellite approach allowing for greater but still scalable customization. ETFs clearly play into a mass or broader customization framework for advisors and wealth platforms to serve end clients. But they also have a role in institutional portfolios which have become more simplified due to labor shortages or cost pressures.

We begin by considering what key characteristics or roles ETF categories can fill in a broader portfolio. We see 10 such characteristics, with examples:

• Core: low-cost broad beta, low tracking error active/smart beta
• Dynamic Growth: thematic equity, convertibles, high beta/growth/momentum equity
• Cyclical Growth: value/cyclical/quality/other factor equity, regional equity, preferred stock, high yield, emerging-markets debt
• Income: dividend equity, overwriting strategies, investment-grade credit, multisector core+/satellite fixed income
• Volatility: low beta equity, defined benefit
• Correlation: long-duration fixed income, hedge-fund strategies, long volatility, digital assets
• Inflation: inflation-protected bonds, real asset/infrastructure/energy/materials equity, commodities
• Liquidity: high-quality short/ultra short/floating-rate fixed income, money-market funds
• Single Solution: target date, defined multi-asset
• Tactical Trading: leveraged/inverse, single stock

Next, we consider the AUM tied to each of these characteristics. Our findings are that core assets account for some 55% of aggregate ETF portfolio AUM. While this is a majority of assets, we’re interested to note that core assets account for about 25% of total fees in the portfolio from a revenue standpoint.

As for satellite characteristics, Cyclical Growth and Income are the most in demand, followed by Liquidity management and exposure to more Dynamic Growth. Inflation, Volatility dampening and Correlation (think hedges) are smaller additions.

Product launches since 2022 generally align with this breakdown, except for the Volatility and Core categories. The latter requires scale, meaning newcomers are unlikely to have success with it. Flows align even more closely and show that core assets have seen much stronger growth in net new assets — likely a function of an equity bull market.

ETF market outlook: Key trends to watch

We see five trends that could unfold within the U.S. ETF industry in the year ahead. 

The first of these is core incursion and differentiation. Market-cap-weight, low-cost ETFs have dominated core equity exposure over the last two years, especially for the U.S. These ETFs have been hard to beat given the outperformance by mega-cap Growth names. But these products’ success has led to increasing concerns about concentration in U.S. large caps, with further worries due to the slow start to 2025 from the “Magnificent 7.”

We also note opportunities for differentiated growth. High-level, the opportunity for product differentiation is linked to the Magnificent 7 becoming just another group of stocks. But we also ask what else could drive differentiated growth opportunities, and note that the nature of rapidly evolving industries is that disruptors often get disrupted. 

Recent market action shows us that Growth really isn’t broken: The equal-weighted NASDAQ-100 is making a comeback year-to-date in a relative sense, and Growth is actually surging outside of the U.S. The opportunity exists to re-engage in Dynamic Growth discussions as investors look for differentiated angles.

We have our eye on platform consolidation. Often, ETF issuers go through cycles of expanding lineups and then culling them. Coming to market is important for many asset-management businesses, given the pressure on mutual funds and the growing popularity of ETFs. But in years 3 through 5, issuers tend to focus on ETFs that can sustain themselves.

We think the aggressive product expansion seen over the past few years should naturally spur a trimming cycle. But with new issues coming to market, there’s also an opportunity for industry consolidation to act as a catalyst for lineup rationalization. Right now, nearly half of issuers with 20 or more ETFs in market see at least 30% of their annual revenue coming from their largest product. While these cash-cow funds help sustain broader product platforms, there’s an opportunity to refocus on which funds are needed to diversify in order to refocus on business profitability. Issuers with a higher percentage of products that aren’t covering their operating costs and low annual revenue per product are more likely to scale back their offerings.

Next we turn to cross-asset competition. One thing we noted from classifying portfolio characteristics is that products no longer compete within traditional defined categories. Core allocations compete for dollars between equities and fixed income. Dynamic Growth can be invested in equities or convertibles. Cyclical Growth also varies across the capital stack. Income can be generated from a number of asset classes.

Going forward, we think product positioning won’t be about selling a product relative to its peers, competing allocations or funds from other asset classes that look to produce a similar characteristic. Being able to manage conversations about education, marketing and distribution along those lines may help position products more broadly within investor portfolios.

Finally, we consider product partnerships. The early days of ETFs saw more partnerships between ETF platforms and more traditional asset managers. Of late, we’re seeing some breakups as companies look to make a more meaningful splash.

We think diversified asset managers with investing intellectual property in a variety of asset classes or portfolio characteristics should consider investing in becoming a standalone issuer. That said, we’re once again seeing an increase in partnership product launches. Improvements in liquidity ecosystems and technology should make more assets “ETF-able,” and we suspect this will lead to more product-partnership launches and greater success.