Asset managers prepare to end 2016 with a deeper understanding of how to adjust for the future: embracing data, developing passive products and acknowledging that the bull run in the markets will eventually end.
In 2017, executives are anticipating an overhaul to the current regulatory landscape, the further proliferation of fintech as well as advancements in alternative product development.
"Investors [can] expect continued evolution and refinement of strategies in the hunt for the Holy Grail of ETFs," wrote San Diego-based Reality Shares CEO Eric Ervin.
Managers are also keeping a close watch on policies from incoming President-elect Donald Trump.
Dana D'Auria, the director of research at Symmetry Partners, predicts the "industry is undergoing a move toward fiduciary standards," regardless of what happens under the new administration.
Ervin and D'Auria, along with Sondhelm Partners CEO Dan Sondhelm, Pure Funds CEO Andrew Chanin and Paul Delligatti, partner at Goodwin, shared their predictions for 2017 with Money Management Executive.
Their submissions have been edited from their original format.
ETFs OF THE FUTURE
Eric Ervin, CEO, Reality Shares
The ETF industry has evolved from plain-vanilla index funds, such as the SPDR S&P 500 ETF, to more refined, smart-beta ETFs.
This shift started when managers realized indexes were continuously underperforming the broader market, inspiring them to try alternative weighting strategies based on factors "smarter" than market-cap. This led to strategies like the PowerShares Intellidex that track risk-return profiles, and eventually the ProShares Dividend Aristocrats, which tracks companies that have grown dividends for at least 25 consecutive years.
In 2017, will there be a way to invest in ETFs that hold the best-performing stocks, avoid the laggards and keep costs to a minimum? My firm, Reality Shares, believes the answer is yes.
These ETFs of the future will offer alternative strategies focused on risk-adjusted return with high upside capture, while simultaneously weeding out low-quality stocks. Previously reserved to hedge fund and institutional investors, these strategies renounce traditional market-cap weighting methodologies and focus instead on weighting by quality.
ETF managers are continuously testing new strategies in the hopes of achieving exposure to alpha-generating segments of the equity market, bringing ETFs of the future from theory to reality. For example, Reality Shares developed DIVY, an alternative ETF that tracks the dividend growth rate of large cap companies. Historically, dividends have delivered significantly lower volatility with low correlation compared to the broad market.
One thing to be aware of is concentration. Holdings of these smarter ETFs of the future will be composed of far fewer constituents than a broad market index - perhaps only 30 or 40 compared to 500. However, if you believe in the quality of the factor the fund is weighted by, less of the best can be better than more of the mediocre.
A FIDUCIARY STANDARD REGARDLESS OF DoL RULE'S FATE
Dana D'Auria, research director, Symmetry Partners
Regardless of what happens with the U.S. Department of Labor rule, our industry is undergoing a move toward fiduciary standards and it is difficult to envision a world where we go back to a commission-lead landscape.
We anticipate the current focus on fees will only grow in the year ahead. Asset managers will be increasingly challenged to justify their costs and to make sure they are in line with best practice.
This will manifest itself in two ways: first, through value-added services such as financial planning, especially niche planning. This will be the greatest differentiator for financial advisors from digital service platforms.
The second way is through lower cost, transparent investments. The move toward passive indexing or enhanced passive investment products will go hand in hand with this. No one ever says that you have to choose the lowest fee product. The problem is that investment strategies can, and do, take years to genuinely validate a higher price tag.
The second problem is that there's no guarantee they ever will, and the evidence suggests many don't. With that vista before you, as an advisor, the easiest and safest option is to minimize costs, regardless of what you think the long run potential for outperformance may be. The good news is that advancements in technology have opened doors to both new discoveries in academic research and lower cost investment tools.
Factor-based investing enables us to harness the power of financial markets at a fraction of the cost of traditional active management. We believe the industry is moving to adopt these smart beta approaches, and we would guess that progression will continue apace.
SEC TO PERMIT SWING PRICING
Paul Delligatti, partner, Goodwin's Financial Industry and Investment Management practices
The SEC adopted Rule 22e-4 under the Investment Company Act of 1940, which requires open-end funds, including certain ETFs but excluding money market funds, to adopt and implement formal, written liquidity risk management programs (Programs). Rule 22e-4 specifically excludes ETFs that qualify as so-called "in-kind ETFs" from certain requirements.
A fund will now be required to assess, manage and periodically review its "liquidity risk," considering certain specified factors. Liquidity risk is defined as the risk that a fund cannot meet redemption requests without significant dilution of remaining investors' interests in the fund.
A fund will generally be required to classify its portfolio investments into one of four liquidity categories based on the number of days within which the fund reasonably expects an investment would be convertible to cash under current market conditions without significantly impacting the investment's market value. These categories are: highly liquid, moderately liquid, less liquid and illiquid.
Fundswill be required to determine, and review no less frequently than annually, its "highly liquid investment minimum," which is the minimum percentage of the fund that must be invested in highly liquid assets. A fund must also adopt procedures for responding to situations where the fund's highly liquid assets fall below its highly liquid investment minimum. Such procedures must be provided for reporting to the fund's board in the event of a shortfall.
A fund will also be prohibited from acquiring any illiquid investment if, immediately after the acquisition, the fund would have invested more than 15% of its net assets in illiquid investments. These funds will be required to review its illiquid investments monthly and the board must be notified if a fund exceeds the 15% limit. This notification must include information regarding plans to bring the fund back into compliance within a reasonable period of time.
MORE FUND ADOPTIONS EXPECTED
Dan Sondhelm, CEO, Sondhelm Partners
The mutual fund industry is likely to see more M&A moves, such as adoptions, in the year ahead.
Many fund firms have good stories to tell, but have a tough time gathering assets. Increased distribution costs, more attention to low fees, and stronger regulations such as the new DoL rule will cause more firms to leave the fund business.
Fund adoption may make sense for firms that prefer to give up the perceived headaches of the fund industry, but want to continue to manage assets and be part of a firm committed to growth that brings platform availability, a sales team, and marketing resources to the table.
For funds with scale, the buyer would pay for the assets up front or over time. For smaller asset managers, the acquiring firm may simply adopt and pay the legal and operations fees. In either case, the acquired firm would stay on as a sub-advisor and would likely participate in ongoing compensation as the fund attracts assets. In some cases, the adopted manager may also sell his firm allowing the manager opportunities to manage more strategies and assets, be part of the marketing process, and earn equity in the acquiring firm.
Fund adoptions may be an opportunity of a lifetime for firms who are looking to partner with funds with a track record to add to their product line, or add assets to an existing, perhaps underperforming product.
Other options to exit include just selling the fund where the manager wouldn't continue to manage the assets. In a liquidation, the manager would lose the assets.
Andrew Chanin, CEO, PureFunds
Looking forward to 2017, the potential for fintech may reflect favorable underlying dynamics on both fundamental and sentiment-based levels. This trend follows not only from the economic potential of integrating digital technology into the financial industry, but also from continued investor appetite for paradigm-changing technologies.
Perhaps one of the most compelling cases for the fintech movement is the sheer number of avenues by which fintech may disrupt the financial sector. While digital lenders often capture the limelight, the diversity of fintech applications is astounding. For instance, online brokerages, digital deposits, automated robo advisories, and data-driven mortgages all may present a striking challenge to traditional financial enterprises.
By offering cost-compression and increased accessibility, McKinsey projects fintech will endanger up to 40% of revenues of certain retail banking segments. In and of itself, mobile payments are democratizing access to financial services, reaching out to the under-banked and those disenfranchised from global financial institutions. Moreover, the increasing availability of sophisticated financial data is enabling a revolution in evidence-based investing, whether it be intelligent risk management or allocations backed by machine learning.
Beyond the economic fundamentals alone, market enthusiasm for fintech solutions remains positive. This favorable investor outlook is evidenced by the substantial capital raises achieved by numerous fintech startups. Not only is it remarkable that Stripe recently raised $150 million for a $9.2 billion valuation, or that Opendoor attracted $210 million in its latest funding round, but it demonstrates that private investors are committing to fintech en masse.
Considering that over 700 companies are pushing the limits of blockchain technology, the vibrancy of the fintech movement may be self-evident.