The rise and rise of ETFs
NOT VANILLA: INNOVATION DRIVING THE INDUSTRY THAT NOW HAS 7 000 PRODUCTS Over 15 years the compound annual growth rate of smart beta ETFs has been 31.9% versus 19% for ‘vanilla’ market cap products.
At the CoreShares ETF Exchange conference last week, Deborah Fuhr, managing partner at ETFGI, recalled that when she started covering the exchange-traded fund (ETF) industry in 1997 there were 21 products listed on world exchanges, with assets of $8 billion. Today there are nearly 7 000 exchange-traded products listed in 56 countries, holding investments worth over $4 trillion.
The ETF industry is 27 years old, whereas the hedge fund industry is 67. “But in June 2015, the assets in the ETF industry overtook those in hedge funds, and at the end of the first quarter of this year it was more than $800 billion larger,” Fuhr said. The uptake in ETF use is still growing, as more investors adopt a ‘barbell’ approach to their portfolios.
“Increasingly they are finding that it’s difficult to identify active or even hedge funds that consistently deliver alpha.
So they are looking to use active strategies on one side and embrace ETFs and indexing on the other side, with the goal of generating alpha through asset allocation.”
Studies show about 90% of long-term returns are due to asset allocation.
nvestors and financial advisors are increasingly using ETFs to gain broad exposure to specific asset classes. “We are seeing significant growth in ETFs because people are seeing alpha differently,” she noted. “For instance your global equity exposure might be through an MSCI world index tracker, but you can then use other ETFs to overweight specific regions like Japan or the US. This allows you to tactically generate alpha, and increasingly we are seeing people do this.”
In these instances, ETFs are often used to express views about where people do or don’t want to be invested, based on what’s happening politically and economically. This allows for more specific risk management. The same applies to balanced portfolios across multiple asset classes. ETFs offer an efficient and cost-effective way to gain or increase specific exposures to fixed income, property and commodities.
ETFs have also become very popular as a way to invest in emerging markets where research is either hard to find or difficult to understand. Smart beta continues to gain popularity. Over the last 15 years the compound annual growth rate of smart beta ETFs has been 31.9%, compared with a 19% compound annual growth rate for ‘vanilla’ market cap products. These funds allow investors to introduce factor tilts (value or momentum), into a portfolio, or address specific needs like providing an income through high dividend products. The nature of ETFs is also opening up interesting new uses. “They are the only product I know of that is democratic in that everyone has access to the same toolbox at the same annual cost, with very small minimum investments,” Fuhr said.
This led to the birth of ‘active ETFs’: actively-managed funds listed on an exchange within an ETF wrapper.
They break down barriers to access. As they can be bought and traded like any share, there’s no need for these funds to be listed on platforms and investors can buy into the fund at the cost of a single security.