Capital Markets Desk: A Year-End Report Card for Industry Predictions in 2019

Looking back on some industry trends David Mann predicted would likely unfold this year.

    David Mann

    David Mann Head of Global ETF Capital Markets,Franklin Templeton

    It is that time of year again! I’m pausing for a moment of self-reflection to look back on my 2019 predictions for exchange-traded funds (ETFs). Coming soon will be my thoughts on 2020. But for now, let’s go through the predictions I made back at the start of 2019, and give myself a grade.

    1. Smart Beta ETF inflows will finally break $100 billion for the year.
    Grade: B-

    In 2017, smart beta flows were around $78 billion. In 2018, the number rose to $86 billion. With around three weeks to go in the year, we currently stand at a whisker under $80 billion.1 While that number clearly fell short of my expectations, if I squint hard enough, there are some encouraging signs. Three of the top four months of inflows into smart beta funds were September, October and November. If I annualized the flows over the past three months, then we would indeed be well over $100 billion. (Maybe my prediction was just a tad premature)

    I am also encouraged that more than 60% of the flows into equity ETFs were from smart beta funds.2

    Unfortunately, that is not how the predictions game works, and 2019 smart beta inflows were right in-line with the prior two years. So, my grade must reflect that.

    2. We will see an increased number of large trades in smaller ETFs.
    Grade: B-

    As a reminder, our universe of funds included those with assets under management (AUM) between $25 million and $100 million and an average volume of over 10,000 shares a day.3 The question was what percentage of those funds would have at least one trade of 10x the average daily volume.

    Last year we saw a little under half (47%) of the eligible funds meeting our criteria above have one trade of 10x.4 I predicted this year we would exceed 60%. Guess what? It was 47% again! I cannot believe it. Just imagine if I would have made a bold prediction that the percentage would stay the exact same at 47%! I should give myself an F for the missed opportunity alone.

    The good news is that investors still seem to be comfortable trading larger blocks in newer/smaller funds.

    3. Something is going to go bump in the night.
    Grade: B+

    The spirit of the prediction from last year was that sometimes trades still occur at prices that are disconnected from the value of the underlying securities. As we mention in these ETF liquidity videos, investors should understand the typical spread of an ETF and then only trade when they see that spread.

    There were a couple examples that I would classify as “bump in the night” issues for ETF trading in 2019.

    a) Trading during the opening auction in newer funds

    Even in our own funds, we had a handful of trades in 2019 that occurred during the opening auction that we felt would have been better served by waiting until the opening markets were established (usually within the first minute of trading). As a reminder, the opening auction sets the official opening price on the exchange. That price is determined by looking all the orders submitted either to buy or sell shares on the open and then finding the price that maximizes that volume.

    For high-volume ETFs, the opening auctions are fairly efficient because of the high number of buy and sell orders submitted as well as the high number of ETF market makers who participate in them. For newer funds with lower average volumes, the success of the opening auction will often be contingent on one ETF market maker being ready to participate—which will not always be the case given the lack of regular auction volume.

    We thus recommend avoiding the opening auctions in ETFs until there is a significant amount of average trading volume.

    b) Industrywide issues like the Securities Information Processor (SIP) going down on August 12, 2019

    In our post from last year, we mentioned that there is a big difference between market volatility and market uncertainty. So, what would cause ETF market makers to be unsure of the price of the underlying stocks within the ETF? We had a good example on Monday, August 12, when there were issues with the SIP, which links and consolidates all the trades and quotes across the US exchanges.

    Doubts about the reporting of the trades means there were doubts about the actual price of the underlying stocks, which means there were doubts on the value of the ETF. When all of that happens, there is a chance for wider spreads in our funds, which was the case in some of them that afternoon. Going back to the point we made a few paragraphs ago, if you knew the typical spread of an ETF, then you would avoid trading when that spread is wider than normal.

    Overall: Not terrible, but the two jumps I was expecting did not quite materialize. That does not mean I am going to shy away from predicting other jumps in 2020. Stay tuned.

    ENDNOTES

    1. Source: Bloomberg as of 12/09/19.

    2. Source: Bloomberg as of 12/09/19.

    3. Universe defined as all US-listed ETFs with assets under management (AUM) between $25 million - $100 million and an average daily volume over 10,000 shares per day as of 12/09/19, according to Bloomberg.

    4. Source: Bloomberg as of 12/09/19.