Exchange-traded funds could gain a further $2 trillion to $3 trillion in assets in the next three to five years, according to a report by Morgan Stanley and Oliver WymanThe rise of ETFs has put pressure on mutual fund fees, forcing many funds to cut costsIn response, mutual funds are expected to invest heavily in ETFs to save moneyA dramatic shift is underway in the investment world.Passive investment products like exchange-traded funds have hoovered up assets at a fast clip in recent years.US-listed ETFs saw $283 billion in net inflows during 2016, taking aggregate assets under management to$2.5 trillion, according to Citigroup.Exchange-traded funds could gain a further $2 trillion to $3 trillion in assets in the next three to five years, according to a big report on the future of the finance industry from Morgan Stanley and Oliver Wyman.Fee pain is comingETFsare cheaper and more transparent than mutual funds, while mutual funds have struggled for performance in recent years.As such, moneyhas poured out of mutual fundsand into ETFs over the past few years. That has forced mutual fundsto compress their fees so that they cancompete.With ETFs set to seetheir share in the US market increase from 15% to40-60% over the next ten years, according to Credit Suisse, fee compression in the mutual fund industry will likely continue.Morgan Stanley estimates that fees charged by active managers could shrink by more than a third in 2017.That's not good news, because lower fees means less profit.The ironyThe price compression that has swept the mutual fund industry has forced money managers to come up with ideas to cut costs in order tosave their bottom line.One such solution they've come up with is a bit ironic.According to Morgan Stanley and Oliver Wyman, mutual funds are now using ETFs, the very funds that have contributed to price compression, to cut their own costs.By investing in ETFs, mutual funds are able to free up time to focus on "more complex alternative investments," the report said.Here's Morgan Stanley and Oliver Wyman's explanation (emphasis ours):"Asset allocators such as Outsourced Chief Investment Officers (OCIO) and Wealth Managers will account for a large proportion of this incremental demand as they increasingly use ETFs at near zero cost to source beta exposure, allowing them to focus their resources on high conviction managers or more complex alternative investments. However, looking beyond 2019, the emerging use of passive vehicles as an integral part of an active fund management strategy will be arguably the more significant dynamic. Currently, Mutual Funds have ~$0.5TN invested in ETFs, much of which is used for liquidity management. We estimate using ETFs rather than the traditional approach of holding individual stocks offers a cost advantage of 5-8 bps in large and mid-cap equities. As Asset Managers search for ways to deliver performance at lower costs, this may mean that mutual funds find themselves among the largest investors in ETFs."The report concludes thatmutual funds will potentially be one of the biggest drivers of growth for ETFs.SEE ALSO:This chart should strike fear into the heart of every professional investor in the worldJoin the conversation about this storyNOW WATCH: Despite the negative stigma, payday loans are not much different from credit cards
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