ETFs in 2017
Each year the ETF industry evolves in a way that is both surprising and predictable. We have keyed in on three themes for this year: Pricing, ETF Lineup & ETF Emotion
By Christian Magoon
1) Pricing - The topic of pricing is fairly predictable when it comes to ETFs since pricing continues to fall. This is a result of competition between massive ETF sponsors and a crop of firms that desire to be massive ETF sponsors. The battle royale will likely continue between firms like iShares, Charles Schwab, Vanguard and perhaps even State Street as they race to "zero" expense ratios in the land of broad-based stock and fixed income products.
To no one’s surprise it is the investor that wins in this battle. Perhaps more surprising though is that a new pricing war may be starting in one of the fastest growing areas of the ETF marketplace – smart beta ETFs. Smart beta ETFs generally use security selection and/or weighting factors that go beyond traditional market cap selection and weighting of an ETF portfolio. Smart beta ETFs seek to outperform through their unique approach and tend to carry higher expense ratios versus traditional ETFs. Pricing in this category has been a fair amount higher traditionally and the area has not seen much in the way of fee wars until recently. Believe it or not, smart beta ETFs from Goldman Sachs began the fee war that has now pulled in other smart beta competitors like iShares and Hartford.
This fee war is just getting started and firms from Invesco PowerShares to First Trust to WisdomTree could join the party. If a full-scale smart beta price war breaks out in 2017, many will be surprised initially but will likely see the inevitability of it in hindsight. Too many billions are flowing into this investment segment for pricing not to become a factor that ETF sponsors use to significantly distinguish themselves. By year end, I think we could potentially see 20%+ reductions in smart beta ETF expense ratios should the fee war heat up. That would be a welcome surprise to investors!
2) ETF lineup – The predictable part of this point is that there will certainly be a slew of new ETFs coming to market in 2017. New ETF issuance has been well documented and even ETF industry insiders are often surprised at the new brands, ETFs and tickers the industry delivers each year. 2017 will undoubtedly see 1) a half dozen mutual fund-type brands enter the ETF marketplace, 2) new types of smart beta approaches like risk-managed or hedged strategies, and 3) many clever new market segments now available in ETF format. (Not sure which of these three categories is the superior path to investor or ETF sponsor success to be honest.)
It seems we could also see the unicorn of ETFs – the bitcoin ETF – emerge from legal review and debut on the market – or maybe not. Either way this ETF – or at least its filings – will go down as one of the most covered ETF stories in years. Less exciting however is the saga of the non-transparent ETF. It appears that ETF structure – one that probably deserves the true ETF unicorn title – may be rehashed again via legal briefs. That saga may prove to be just as long as getting to the bottom of the Star Wars series.
So what could be surprising here in the land of the ETF lineup? How about more ETF closures? It seems that closing ETFs doesn’t damage the reputation of sponsors as much anymore, and thus I believe more ETF sponsors will right-size their product lines this year. If State Street and iShares can do it, many others can as well. While this may be surprising to many, the reality is that this healthy exercise is important to the ETF industry. Like a gardener who trims trees and bushes, an overgrown ETF industry isn’t healthy for investors or the industry itself. ETFs with little hope of attracting assets and consequently becoming viable don’t generate any value for investors or the industry. They become clutter. So in 2017, I hope many more ETF closures will occur.
The second surprise is merger and acquisition activity continues to rise with one top 10 ETF sponsor purchased and many below that are involved in deals. Why a top ten? I think there are several ripe for the taking and owning a top ten could have huge ancillary benefits for an asset manger like a large mutual fund provider. Take a look at Invesco and their gem PowerShares as a quick example. Great transaction that greatly helped Invesco. When looking below the top ten ETF Sponsors, it is far more prudent to buy a brand and team in the ETF space then to build one internally. See the first version of Northern Trust ETFs or Russell’s only ETF attempt for some background. Instead, the existing footprint argument allows firms to buy into the ETF business and migrate and/or integrate their intellectual property into ETFs alongside an experienced team. More deals seem to be getting done in that paradigm and I think we see an increase in 2017 as non ETF Sponsors realize they need to be in the ETF business or risk becoming caught behind the curve.
3) ETF Emotion – Predictably the emotion around ETFs – the industry, media coverage, investors – appears to be very positive. ETFs are reducing costs, providing convenient access to many previously hard to access market segments and are now featured across the financial media landscape. While I see this continuing, I do think that many casual ETF fans would be surprised to realize that there are many asset management related firms that do not like ETFs. While these haters aren’t exactly the same firms losing assets under management to ETFs, they are likely more similar than not. That motivation – often but not always financial – leads to several stories a year that are best described as new chapters in the “Davinci Code of ETFs.” If you are familiar with the DaVinci Code then you know that half truths and lies are often used to connect people and events within the story. This seems to increasingly happen to the ETF vehicle as its success and usage grow.
From stories about ETFs causing significantly more volatility in the overall stock and bond market, to ETFs being responsible for increased U.S. job losses to ETFs providing too much convenience to investors, these efforts are widespread and often end up being comical in their ambition. The point is that 2017 is likely to see more attacks – dare I even say fake news – on the ETF vehicle by various groups. My tip is to take these attacks seriously – there may be merit behind these attacks after the evidence is weighed – and to be sure to not forget to follow the money behind these allegations. The ETF vehicle is changing the asset management landscape by reducing costs, increasing convenience and boosting access. While these are great positives for most investors, it is important to realize that losers in this transformation that may seek to invent attacks on ETFs.
Inside the World’s Largest ETF Conference
A behind-the-scenes look at Inside ETFs 2017
By Christian Magoon, Founder and CEO of Amplify ETFs
Inside ETFs 2017 just concluded in South Florida, and this year’s event was the largest and perhaps most memorable ever. The 2017 conference not only marked the tenth anniversary of the world’s largest ETF event, it also coincided with the Dow Jones Industrial Average finally hitting the 20,000 mark. The 2,000 plus attendees at this year’s conference were upbeat, and Amplify was pleased to once again speak and exhibit at the conference.
Here are some key conference takeaways.
1) New faces
The exhibit halls and panels were packed with many new firms involved in the ETF ecosystem. From new ETF sponsors to index providers to service providers, the number of new players was substantial. While new to ETFs, many of these new faces are not new to the asset management ecosystem. Several mutual fund brands, for example, have transitioned to offering ETFs and were active at the conference. The ETF tent is enlarging, and the selection of “pure play” ETF sponsors seems to be falling behind mutual fund affiliated ETF sponsors.
2) Index evolution
The universe of index providers is also growing in terms of new firms and the solutions they are offering. Most notable was the amount of index providers pitching dynamic indexes – indexes that shift allocations quickly based on market dynamics in order to maximize alpha or reduce risk. These types of indexes should fare well being tracked by ETFs due to the tax efficiency of the ETF structure.
3) Lights, camera, action
A variety of financial publications – from TV to print – covered the conference. In years past coverage was dominated by ETF industry media outlets, but the ETF industry recently has become of interest to mainstream investors. Several news stories broke at the conference, including AmplifyETFs announcing a new investment structure designed to incubate ETFs.
4) Trump factor
You can’t watch a segment of financial television or read an investing periodical without hearing about the Trump effect on markets. Inside ETFs 2017 was no exception. Speakers and panels constantly addressed the Trump factor. Clearly the investment crowd is still trying to figure out Trump policy and its potential winners and losers. The Federal Reserve interest rate policy in 2017 also seemed to be a popular topic.
5) Price cuts
As usual, the continued march downward of ETF price points was discussed in several panels. It is now possible to build a fairly diversified equity and bond portfolio via ETFs with expense ratios in the 20bps or less range. Broad based equity and fixed income exposure (not alpha) is becoming cheaper each year. That is a great trend for investors and likely to continue until these type of ETFs have an expense ratio that equals zero.
6) ETF Bubble
After attending this conference, one has to ask the larger question: Have ETFs hit a bubble?
Historically I have answered that question by comparing the ETF industry to the mutual fund industry in terms of number of product companies and funds being offered. By that comparison, the ETF industry is still well behind the mutual fund industry.
However, I am concerned by anecdotal evidence I see at conferences like Inside ETFs that the ETF industry is attracting sponsors without a strong commitment to the space. Case in point, the ETF sponsor booth across from the Amplify ETFs booth was a very large multi-billion-dollar traditional asset manager, which now has ETFs. The booth was mostly unmanned throughout the conference and had little to no marketing support in terms of materials and signage. Were they just at Inside ETFs to check a box? Are they really committed to growing their ETF business?
These questions may seem elementary, but large mutual fund or 401k-centric companies are under pressure to provide an ETF plan. A variety have launched ETFs, but several examples seem to point to these launches either being done for show or lacking a strategic plan. As an ETF market participant for more than ten years, I am worried by the rise of these types of ETF franchises. One can easily look back at the very public failures of Russell Investments and Northern Trust’s initial ETF lineups to see that there are no guarantees of success in the ETF business.
Inside ETFs 2018 is already being planned, and no doubt about it, the conference will have more professional ETF investors and ETF sponsors than ever before. The future of the ETF vehicle looks bright as asset managers and index providers continue to build out a set of tools for the growing user base of ETFs. While markets will be uncertain in 2017, there will be many ETF solutions available to protect against or harness the trends moving stocks, bonds and commodities.
WHY ETF TRANSPARENCY MATTERS NOW
An important ETF characteristic during market volatility
By Christian Magoon
Whenever increased market uncertainty occurs, ETF investors should utilize a feature most ETFs offer: portfolio transparency. The majority of ETFs reveal their exact portfolio holdings on a daily basis via their official website. This real time portfolio transparency allows investors to better understand and address portfolio specific risks. While important during times of market volatility, portfolio transparency is just as valuable to any investor seeking to diversify and follow a long-term asset allocation plan.
A transparent portfolio provides the foundation on which to build both proper portfolio diversification and asset allocation. Proper diversification helps to reduce the concentration risk of an investment portfolio. When an investor seeks to diversify, it is important to know exactly what is owned inside that portfolio. Constant portfolio transparency allows for more accurate portfolio data and decisions. In another related effort to address portfolio risk, asset allocation is a method that tailors a portfolio to best fit an investor’s risk tolerance and time horizon. Predictably the more frequent the transparency of the portfolio, the more precise the asset allocation can be.
Accurately implementing and monitoring a portfolio’s asset allocation and diversification is important in all types of market environments. The portfolio transparency of ETFs provides investors with current and complete information to base crucial decisions on. Should market volatility – or risk - increase in 2016, ETF transparency will only matter more to investors as they seek to understand, position and monitor portfolios in light of marketplace risks.
Opinions expressed are subject to change at any time, are not guaranteed and should not be considered investment advice. Diversification does not assure a profit or protect against a loss in a declining market.
Alpha is a measure of investment performance against a market index used as a benchmark.
Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole.
The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the NASDAQ. One cannot invest directly in an index.
Past performance does not guarantee future results.