ETFs Past, Present, And Future

ETFs Past, Present, And Future Lee Kranefuss ETF Opportunity Partners LLP March 16, 2012

Agenda Where we came from Where we are Where we are going Products Market Industry

ETFs have come a long way from 1999. 1999 20 ETFs in U.S. 1 in Canada $20B AUM 2012 Nearly 3000 ETFs globally Every continent (except Antarctica) Ca. $1.5T AUM Nearly 100 providers

Early perception of ETFs Index funds Why accept mediocrity? Low performance Which car would an ETF be? - Chevette A specialty product

Why have ETFs become so popular? Diversification Low cost Tax efficiency Market access A program trade in a box

The largest ETFs are benchmark products Benefits of full replication/collateralization Major top-down building blocks Multi-dealer / narrow spreads / liquidity

What is in the tail? Leveraged/Inverse product Finer slices of the onion active product

What does the future hold? Trends, Innovations, and Risks 1) Continued robust growth and adoption 2) The disaster that will occur 3) Truth-in-labeling 4) Collateralization of most synthetics 5) Consolidation 6) Next Generation Beta (Beta 2.0)

ETFs will continue to grow rapidly especially in Europe, Asia, and LatAm ETFs have grown every year since introduction globally Continued double-digit rates Tremendous benefits of ETFs are the driving force behind adoption Access to more of the market for more investors Low cost Tax Portability Thematic investing The power of information

ETF growth forecasters predict continued asset gathering ETP 5yr Annual AUM Growth Forecasts AUM (US$T) 5-year CAGR 26.7% 16.7% Sources: McKinsey Analysis, August 2011 BlackRock "ETF Landscape, Year-end 2010

The European Savings Landscape has significant runway for growth ETP, Structured Product, Mutual Fund and Household Deposit Assets, 2006-2010 uro Billions Household Deposits Mutual Funds Structured Products Exchange Traded Products 7,000 6,000 5,000 5,355 5,277 5,173 5,406 5,385 6,009 4,690 5,230 4,000 3,939 3,000 2,000 1,000 0 2006 2007 2008 2009 2010 0 Sources: Arete Consulting European Banking Federation Lipper FMI Cerulli Associates Note: 2010 Household Deposit data unavailable

At some point, a real disaster will occur With so many sponsors and funds, something will go wrong We have come close (Flash Crash, Lehman grandmothers) What will the headline read? ETFs fail C.f., the Flash Crash

Truth-in-Labeling will be mandated ETPs consist of ETFs Synthetic ETFs ETNs Customers are walking with their money Governments will mandate more clarity: Know what you own

Considerable pressure will cause many synthetic funds to become physical funds (I)s seen a shift in preference 320 280 Assets (US$B) AUM: European ETF Physical and Synthetic AUM, 2005 Q3 2011 Physical Synthetic Number of ETFs 900 800 240 Number of ETFs: # physical # synthetic 700 200 160 600 500 400 120 300 80 200 40 100 0 2005 2006 2007 2008 2009 2010 Q3-11 0 ETF AUM (US$B) 2005 2006 2007 2008 2009 2010 Q3-11 Physical 41.3 64.1 80.6 76.4 125.0 155.1 157.0 Synthetic 13.6 25.6 48.0 66.4 101.9 128.6 110.1 Total: 54.9 89.7 128.5 142.7 226.9 283.7 267.1 Number of ETFs 2005 2006 2007 2008 2009 2010 Q3-11 # physical 138 184 231 252 314 385 440 # synthetic 27 89 192 383 515 683 765 Total: 165 273 423 635 829 1068 1205 Sources: BlackRock Investment Institute Bloomberg

Considerable pressure will cause many synthetic funds to become physical funds (II) Why synthetic? Very, Very favorable economics to producer Quick & easy to issue What will drive collateralization? Customer awareness and fear: year 5 of financial crisis Bank capital needs (see consolidation as well) Basel III - Synthetics will no longer be as economic

Consolidation is the wave of the future Too many marginal players piling in s seen Global ETP AUM Market Share based on assets as at 30 September 2011 Market Share (%) United States - US$969B AUM Europe - US$301B AUM ROW - US$158B AUM 100% 90% Other (75 providers) 18% 80% 70% Vanguard 16% Other (44 providers) 39% Other (100 providers) 48% 60% 50% 40% State Street 24% Lyxor 13% Db x-trackers / db ETC 15% State Street 9% Nomura 13% 30% 20% 10% ishares 42% ishares 33% ishares 30% 0% 0 300 600 900 1,200 1,428 ETP AUM (US$B)

Many forces will drive consolidation Sub-scale entrants can t make material profits Collateralization and capital forces will increase the number of unprofitable entities Fear of a disaster scenario (or consequences of a disaster) Reduction of clutter And need for identifiable and strong brands with longevity Market-maker capital shortage Only the strong products can survive

Next Generation Beta (NGB) is a very bright spot on the horizon ETFS started out as benchmark index products Attempts to innovate have been side-shows of sorts Leveraged & inverse Fundamental indexes Synthetic Active ETFs (but not terminally so) NGB is the brightest spot on the horizon in product development

Next Gen Beta spans a range of directions Access to more asset classes in liquid, bite-sized chunks Equities, Fixed Income, Commodities already.then. Private Equity & Hedge Funds Real Assets Factors Why Factors? Who made money in the California gold rush? - Wells Fargo, Levi Strauss, Union Pacific..