The turn of the calendar to a new year brings new year’s resolutions—and predictions. While many market pundits are now making their prognostications for the year ahead, David Mann, head of Capital Markets, Global Exchange-Traded Funds (ETFs), doesn’t claim to have a crystal ball that will reveal where the market is headed next. He does, however, offer some practical insight on the state of the ETF industry and some trends to look out for in the year ahead.
I hope everyone had a happy and healthy holiday season! Last month, I discussed one of the great end-of-year traditions, tax-loss harvesting. Right up there on the “traditions” scale (although less of an ETF tradition) is to have a January predictions post about what we should be expecting in the new year.
While this is a financial industry blog, let’s start with some predictions I will not be making here:
- The end-of-year price of the S&P 500 Index
- The number of interest rate hikes we will see in 2017
- A market call on a particular country or sector
I am also going to refrain from making any predictions specific to ETFs, such as where industry-wide ETF assets under management and flows are headed in 2017 or where ETF trading volume will net out. Though, if pressed, directionally, I’d say that I think each is likely to be higher, as I do believe we’ll see a continuation of current trends.
Instead, what I really want to touch on are a few issues or topics that will be on my radar in 2017, which I think ETF investors should pay attention to, as well.
Non-Traditional ETF Strategies Are Here to Stay
There is no question that ETFs have been growing in popularity worldwide and have been attracting an increasing share of investor dollars. In 2016, more than $270 billion flowed into ETFs—the majority of which were US ETFs.1
Within the ETF marketplace, investors have been increasingly gravitating toward relatively new types of ETFs known as “strategic beta” or “smart beta” ETFs, which have garnered more than $40 billion in new assets globally in 2016.2These funds offer an alternative to purely market capitalization index-tracking vehicles.
We are also seeing increased interest in active ETFs, especially those holding fixed income securities. As investors have become more and more comfortable with the ETF wrapper, they are becoming more open to different solutions within the general asset class beyond a basket defined by market capitalization. I expect this trend to continue.
For decades, market capitalization-weighted indexes (such as the S&P 500 Index for US large-cap investing) have served as the foundation of a passive approach to ETF investing, with many investors viewing them as an efficient way to gain broad market exposure.
However, many are discovering that traditional index investing comes with certain drawbacks and inherent risks that more advanced approaches to index construction may help to mitigate. One such methodology (strategic beta) constructs indexes based on criteria other than market capitalization.
This could include a simple set of rules (holding securities in equal weights) or a more complex methodology (using multiple factors such as quality and value). In contrast, with traditional, cap-weighted indexes, the largest, highest-priced companies will make up the largest portion of an index. That may not be desirable.
Looking at active ETF products, the key distinction is the word “active.”