Where do ETFs lead the asset management industry to next?
The ETF market continues to set records, capturing billions worth of inflows monthly. At the end of May, there were over 5,000 ETFs listed globally, representing close to $4 trillion in assets, according research firm ETFGI.
But low costs and an investor shift toward passive are only part of the reasons why exchange-traded products are leading change across asset management, according to four industry experts.
ETFs, they posit, have been boosted by a trio of trends coming together at one time: the industry's adoption of new technology, such as robo advice; innovation developing new exchange-traded products; and a host of regulatory changes working in their favor, including the Department of Labor's fiduciary rule, which despite industry opposition, was allowed to take effect this month.
Technology, for instance, "has made investing in index-tracking funds, passive or smart beta/factors cheaper," says Tim Baker, director of product strategy at Glastonbury, Connecticut-based Symmetry Partners. "It is no longer necessary to spend a lot of money on research to find companies with low P/E ratios, or high ROE, or stable income."
It's worth paying attention to the industry's biggest firms. Vanguard, Blackrock and State Street have 83% of U.S. ETF assets, 50% of total ETF revenue and own the 50 largest ETFs, according to Bloomberg.
Edited versions of submissions from ACSI Funds, Toroso Investments, Symmetry Partners and CFRA Research to Money Management Executive appear below.
The rise of ETFs will not lead to the next financial crisis
Kevin Quigg, chief strategist, ACSI Funds
As ETFs continue to multiply in numbers and accumulate assets from across the globe, a few skeptics have emerged questioning the product class' overall impact on the health of broader financial markets. Many have even gone as far as saying the emergence of ETFs will cause (or add to) the next financial crisis. However, these arguments are fundamentally flawed in a number of fashions.
For one, relative to the broader equity and fixed income markets, ETFs represent a very small portion of total assets. Secondly, critics often erroneously use the terms indexing and ETFs interchangeably. Also, many believers in the theory that ETFs will lead to the next financial crisis cite fears of ETFs removing liquidity from the market. However, ETFs actually add liquidity and even provide a "buffer" during times of market uncertainty. For example, high-yield bonds are fairly illiquid by nature.
During the credit crisis, there was more selling than buying of high-yield ETFs. Because of the exchange-traded nature of these products, market makers matched whatever buyers they could find with shareholder orders looking to sell. By doing this in the secondary market, the underlying bonds themselves were unaffected until all the natural buyers were exhausted. Put another way, the "worst case" scenario for an ETF is that it devolves to the same place most buyers and sellers begin.
In short, don't be wary of ETFs. Their existence will not be the impetus behind the next financial crisis.
ETF industry to grow as result of DoL's fiduciary rule
Mike Venuto, chief investment officer, Toroso Investments
With the initial rollout of the DOL fiduciary rule, it's now that brokers will have to behave like advisers and act as a fiduciary. This means the end of high hidden fees. If the fees must be disclosed, ETFs are usually going to be the lowest cost solution. Advisers will have to defend and document their decisions and justify fees, which is good for traditional beta. It's also good for smart beta and ESG because they have clear value propositions.
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Our research into the ETF industry can help show why advisers chooses one over the other. For example, BlackRock keeps 30% of the security lending revenue generated on their funds whereas State Street gives 100% to the fund and client. Vanguard votes proxies focused solely on company growth whereas BlackRock has a clear ESG voting policy.
In order for ETFs to grow in the post-DOL world clear independent research will be necessary to document and justify the value propositions. We believe investors need to "look under the hood" and embrace the transparency of ETFs. At Toroso we utilize proprietary tools to evaluate ETF ownership influence, active share cost and many other fundamental factors.
Additionally, the DOL rule specifically sites ESG as a metric that can be used to make investment decisions. Recently ETF.com made ESG ratings from MSCI available for free to investors. It is a great first step, but more research will be needed to comply with the DOL. We feel the DOL rule implementation is great for both individual investors and ETF industry growth.
Technology drives fee compression amid move to passive funds and ETFs
Tim Baker, director of product strategy, Symmetry Partners
As money moves to cheaper passive options like index mutual funds and ETFs, the underlying strategy becomes commoditized, particularly in traditional market cap weighted index vehicles. This is because there is only one way to measure market cap, so the investor question becomes, "Who can do it cheapest?" This causes fierce competition and the largest players can (and do) lower fees to scoop up assets. Traditional market cap fund launches make less and less sense as State Street's SPDRs, BlackRock's iShares, and Vanguard ETFs essentially own the space. Tracking the S&P 500 alone, these vehicles hold $412 billion of assets.
Technology has made investing in index-tracking funds, passive or smart beta/factors (to outperform passive) cheaper. It is no longer necessary to spend a lot of money on research to find companies with low P/E ratios, or high ROE, or stable income. Those attributes can easily be screened thanks to the evolution of technology. Related to that, traditional active managers (those seeking excess returns through stock or sector selection) have not delivered performance to demonstrate that their intellectual capital is worth premium fees.
Investors have clearly picked up on this and money is leaving traditional active in favor of cheaper factors or ultra-cheap traditional passive. This has meant lower fees for clients, which impacts revenues and, to a lesser degree profits, for asset managers. The question from here is who can gather the assets to replace those revenues with volume?
Actively managed bond ETFs expected to gain popularity
Todd Rosenbluth, director of ETF and mutual fund research, CFRA Research
Many mutual funds have been bleeding assets as institutional investors, advisors and retail investors gain comfort with ETFs. Vanguard and iShares, the two largest ETF providers, pulled in combined $160 billion year-to-date through May, with the largest flows to lower-cost well-diversified equity and bond ETFs.
Newer ETF entrants Goldman Sachs and JPMorgan gathered $1.5 billion with their primarily smart-beta index based lineup. To CFRA Research, this highlights that while the ETF pie is growing, attracting incumbent providers is a challenge.
While bond mutual fund flows have been more stable than equities, a Cerulli adviser survey shows that many plan to move away from mutual funds and individual bonds. Half of the respondents say they plan to increase the use of bond ETFs in the next three years. Only 23% and 18% of advisors aim to add individual bonds and bond mutual funds, respectively, according to the report.
We expect actively managed bond ETFs to gain attention. This year, prominent firms TCW and Wellington Management partnered to sub-advise an active bond ETF offered by First Trust and Hartford.
The products join a small but growing group of bond ETFs managed by experienced active managers from DoubleLine, Fidelity, Guggenheim and Pimco. CFRA expects that more firms will need to enter the ETF market. Though it might cannibalize their own mutual fund products, it is better to keep money in house than lose it to a competitor.