The ETF industry has rapidly evolved over the past decade. There were roughly 350 ETFs in 2006; currently, there are more than 1,900 ETFs competing for over $2 trillion in assets under management in the United States. One of the primary reasons for this rapid rise in ETF usage is because ETFs give institutional and retail investors the ability to express and execute their investment views in an efficient, low-cost, highly liquid, tax efficient and transparent way – something that was not previously available to them.
Below we take a quick look at three ETF trends for issuers and investors alike to keep an eye on in the coming years.
Product Proliferation in the ETF Space
The U.S. ETF industry is an increasingly saturated marketplace, crowded with firms eager to share some of the assets flowing into this fast-growing corner of the industry. There is definite product proliferation with a raft of new issuers hitting the market. While many are jumping on the “smart-beta” approach, investors need to understand that the advantages these factor-tilts (such as low volatility, momentum, quality and dividend yield) can bring to a fund take a long time to play out into positive returns.
The wide range of products and strategies being marketed to investors makes it increasingly difficult to distinguish between innovation and (possibly expensive) fads. Investor education and ETF due diligence also becomes paramount when it comes to evaluating the merits of these strategies and index methodologies involved, as well as choosing between a wide variety of strategies.
Given the saturation in the ETF space, the ability to transform ETFs into effective solutions that address the needs of specific investor segments may be a particularly important factor in competing successfully.
Each firm will have to evaluate and formulate its own plan, based on its own resources and objectives.
The role of advisors, index construction, vendor support for advisors and ETFs’ low cost are all going to continue to be factors influencing wider ETF adoption.
Move Towards ETF-Managed Portfolios?
ETFs are essentially a tool that helps investors and advisors build wealth for their clients and meet their goals. Understanding the investor’s goals is, first and foremost, paramount. ETF selection should only come after analyzing the investor’s goals through a holistic framework that outlines criteria such as risk tolerance, return expectations, liquidity expectations, time horizon and tax considerations. ETFs should not be thought of as stand-alone pieces, but instead as pieces of an integrated and well-thought-out plan.
ETF managed portfolios are investment strategies that hold more than 50% of assets invested in ETFs and can be divided into three major themes – strategic, tactical and a hybrid mix (of both strategic and tactical).
Investors of all types – be it retail, institutional or financial advisors – have been searching for a better way to provide for more downside protection in volatile markets since the 2008 financial crisis. ETF-managed portfolios have emerged as a fantastic solution, as they offer clients goal and outcome-oriented products.
According to Blackrock, ETF-managed portfolios currently hold about $350 billion in assets globally. BlackRock predicts that ETF-managed portfolios could double to over $700 billion by 2020, as institutional investors increase allocations to these strategies.
There are several reasons for this wide-adoption of ETF-managed portfolios. Firstly, the growth is being driven by clients’ needs for focused outcomes/solutions (as an example, a low volatility dividend income ETF is a focused outcome). Secondly, the sophistication of ETF products allows investors to get specific exposure to what they are looking for, whether it be an asset class, an investment strategy or exposure to certain countries/markets or sectors. Thirdly, industry disruptors such as robo-advisors are providing customized ETF-managed portfolios to a growing number of investors.
More and more investors, active managers and advisors are adopting ETFs due to their many benefits – namely, low expense ratios, high liquidity, tax efficiencies, diversification benefits and risk management, and the flexibility they allow investors as their goals change or as market conditions change.
The challenge for advisors will be controlling investor/client behavior, steering clients into good products that fit in with their strategic asset allocation and tactical needs, and protecting their ETF investments from market malfunctions and downturns.
The Future of Robo-Advisors?
Technology could also challenge ETF firms, with its power to radically alter the way investment advice and products are evaluated and consumed. Robo-advisors, armed with algorithm-driven, web-based platforms, are succeeding by identifying key consumer demands, especially among millennials – the use of technology to deliver financial advice and cheap, index-based ETFs to lower the costs of investing. Investment industry incumbents are finally taking the threat of robo-advisors seriously. Asset managers are increasingly focusing on the robo-advisor as a distribution channel and are acquiring/launching their own robo platforms to distribute their ETFs. For instance, Charles Schwab launched its Schwab Intelligent Portfolios, while Vanguard recently launched its Personal Advisor Services.
There are several concerns for robo-advisors in the future. The first question is if they can compete with traditional firms who have much superior economies of scales, and are able to respond quickly at an extremely low price due to their vast resources. Moreover, traditional asset managers are able to charge fees on the underlying ETFs through securities lending, which gives them a significant advantage over smaller robo-advisors. The second question is if robo-advisors can make young millennials stick with them as long-term clients. To compound matters for robo-advisors, millennials simply don’t have many assets, at least as of now.
Algorithms and automation are upending the financial profession. But do they lead to better outcomes in the long-term? Only time will tell. Human capital is still going to be the bedrock of any approach to building portfolios and financial planning. Investing tools based solely on technology simply cannot account for investors’ emotional behavior. Humans and robos will likely have to work in harmony in the near future.