The exchange-traded fund industry stands on the verge of unprecedented expansion as a long-awaited Securities and Exchange Commission rule change could nearly double the number of available ETFs within a single month. Fund expert Dave Nadig warns that the current market of approximately 4,000 ETFs may balloon to over 7,000 as traditional mutual fund managers gain approval to offer ETF share classes of their existing products.
What to Know:
- The SEC is expected to approve a rule allowing mutual fund companies to create ETF versions of existing funds, potentially adding 3,000 new products
- Currently 53 mutual fund firms have filed for the ETF share class extension, creating what experts call an "enormous burden" for investors to evaluate
- Most new ETFs will be traditional strategies like large-cap growth funds, not exotic investments, though some concerning trends emerge in illiquid assets
Traditional Managers Enter ETF Arena
Nadig, a financial futurist and ETF specialist, described the coming wave as "an absolute tsunami of product" during a recent "ETF Edge" podcast appearance. The transformation represents what industry observers have called "a game changer" for asset management. Even before the rule change takes effect, 400 new ETFs have already launched this year, spanning everything from single-stock funds to income-generating products designed to limit equity risk.
The popularity surge has solid foundations. ETFs offer daily trading and liquidity across major asset classes, relatively low fees, and tax-efficient trading structures. This year alone, over $400 billion has flowed into ETF products. Vanguard Group's S&P 500 ETF, trading under the ticker VOO, appears on track to break the annual inflows record it established just last year.
Most incoming products will represent "pretty boring" strategies, according to Nadig. Large-cap growth funds and core equity income products from established mutual fund companies will dominate the new offerings. "Lots of very traditional asset allocation products," he explained, noting these won't introduce "giant new asset classes" like cryptocurrency or private credit vehicles.
Active Management Faces Familiar Challenges
The mutual fund industry's track record raises concerns about the flood of new options. Active managers have historically struggled to beat index performance while charging significantly higher fees than passive alternatives. Vanguard and BlackRock's iShares have built dominant positions in both mutual funds and ETFs precisely because of this performance gap.
However, active strategies are gaining traction in the ETF space despite representing a smaller absolute share of assets. These approaches account for significant portions of both 2024 flows and new launches. The positive aspect of the ETF share class conversion involves fee structure. Managers should offer strategies at their lowest institutional fee levels, making these products more accessible to individual investors.
"If you genuinely want access to one of these company's products, this will be the best way to do it," Nadig said, while maintaining reservations about active management's historical performance.
Warning Signs In Exotic Products
Straight-to-ETF strategies targeting new asset classes present greater risks. Private credit serves as a cautionary example despite receiving substantial attention since the first ETF launch in this category. State Street and Apollo Global Management partnered to launch the inaugural private credit ETF this year under ticker PRIV, but results have disappointed.
PRIV launched "against the SEC's wishes, the only time that has ever happened," according to Nadig. The fund has attracted roughly $54 million from investors, including any seed money from managers. Daily trading volume remains in the "thousands of dollars," leading Nadig to conclude it has "absolutely fallen off a cliff." Investors may view it as "just another expensive bond fund."
"I don't think there is huge demand for private credit but there is a huge supply of private credit," he observed.
Private Equity Draws Retail Interest
More promising developments appear in ETFs providing access to privately held companies. The ERShares Private-Public Crossover ETF, trading as XOVR, holds SpaceX as its largest position at nearly 10% of the roughly $300 million fund. Fintech company Klarna represents the second-largest private holding at approximately 0.5%.
Investment Company Act of 1940 regulations limit funds to 15% allocation in illiquid securities, so XOVR maintains significant publicly traded stock positions alongside private holdings. "There is real demand there," Nadig said. "I think private equity has real retail cache."
Structure Limitations Emerge
Complex trading strategies raise fundamental questions about ETF suitability for certain investment approaches. Illiquid securities often work better in interval funds or closed-end funds rather than daily-traded ETF structures. The SEC recently signaled interest in expanding retail access to these alternative vehicles.
"That's an appropriate response to get people into the less liquid vehicles," Nadig explained, adding skepticism about universal ETF application: "I'm kind of a seller on the 'everything should be an ETF' narrative."
Capacity constraints pose additional challenges in smaller market niches. Fund managers face difficulty finding suitable securities as assets grow, while heightened volatility creates trading stress. During credit crises, when investors seek exits from funds holding illiquid fixed-income positions, ETF structures experience unique pressures.
"You can't close the fund, you can't shut an ETF, or if you do, it will trade like wild, a crazy pattern with big discount-premium swings," Nadig warned.
Closing Thoughts
The anticipated ETF expansion will primarily challenge investors to evaluate traditional active management strategies in a new wrapper, while more innovative products highlight fundamental mismatches between illiquid investments and millisecond trading structures. As Nadig emphasized, the flood of options creates an unprecedented burden requiring careful homework from both individual investors and advisors navigating this transformed landscape.